China's Economic Policy Impact on the United States

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CHINA’S ECONOMIC POLICY IMPACT ON THE UNITED STATES

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CHINA’S ECONOMIC POLICY IMPACT ON THE UNITED STATES

MARY JO DEVALAND EDITOR

Nova Science Publishers, Inc. New York

Copyright © 2009 by Nova Science Publishers, Inc. All rights reserved. No part of this book may be reproduced, stored in a retrieval system or transmitted in any form or by any means: electronic, electrostatic, magnetic, tape, mechanical photocopying, recording or otherwise without the written permission of the Publisher. For permission to use material from this book please contact us: Telephone 631-231-7269; Fax 631-231-8175 Web Site: http://www.novapublishers.com NOTICE TO THE READER The Publisher has taken reasonable care in the preparation of this book, but makes no expressed or implied warranty of any kind and assumes no responsibility for any errors or omissions. No liability is assumed for incidental or consequential damages in connection with or arising out of information contained in this book. The Publisher shall not be liable for any special, consequential, or exemplary damages resulting, in whole or in part, from the readers’ use of, or reliance upon, this material. Independent verification should be sought for any data, advice or recommendations contained in this book. In addition, no responsibility is assumed by the publisher for any injury and/or damage to persons or property arising from any methods, products, instructions, ideas or otherwise contained in this publication. This publication is designed to provide accurate and authoritative information with regard to the subject matter covered herein. It is sold with the clear understanding that the Publisher is not engaged in rendering legal or any other professional services. If legal or any other expert assistance is required, the services of a competent person should be sought. FROM A DECLARATION OF PARTICIPANTS JOINTLY ADOPTED BY A COMMITTEE OF THE AMERICAN BAR ASSOCIATION AND A COMMITTEE OF PUBLISHERS. LIBRARY OF CONGRESS CATALOGING-IN-PUBLICATION DATA ISBN: 978-1-61728-186-0 (E-Book) Available upon request

Published by Nova Science Publishers, Inc.  New York

CONTENTS Preface Chapter 1

Chapter 2

vii China’s Growing Demand for Oil and Its Impact on U.S. Petroleum Markets Congressional Budget Office U.S.-China Trade: USTR’s China Compliance Reports and Plans Could Be Improved United States Government Accountability Office

1

61

Chapter 3

China’s Trade with the United States and the World Congressional Research Service

117

Chapter 4

China - U.S. Trade Issues Congressional Research Service

167

Chapter 5

China’s Economic Conditions Congressional Research Service

203

Chapter 6

China’s Currency: A Summary of the Economic Issues Congressional Research Service

235

Index

245

PREFACE Since the initiation of economic reforms in 1979, China has become one of the world’s fastest-growing economies. From 1979 to 2007 China’s real gross domestic product (GDP) grew at an average annual rate of 9.8%. Real GDP grew 11.4% in 2007 (the fastest annual growth since 1994). While China is expected to continue to enjoy rapid economic growth in the years ahead and could become the world’s largest economy within a decade or so, it faces a number of challenges, including widespread corruption, an inefficient banking system, over-dependence on exports and fixed investment for growth, pollution, widening income disparities, and growing inflationary pressures. The Chinese government has indicated that it intends, over the coming years, to create a “harmonious society” that would promote more balanced economic growth and address a number of economic and social issues. Trade and foreign investment continues to play a major role in China’s booming economy. From 2004 to 2007, the value of total Chinese merchandise trade nearly doubled. In 2007, China’s exports (at $1,218 billion) exceeded U.S. exports (1,162 billion) for the first time. China’s imports were $956 billion and its trade surplus was $262 billion (a historic high). Well over half of China’s trade is conducted by foreign firms operating in China. The combination of large trade surpluses, foreign direct investment flows, and largescale purchases of foreign currency have helped make China the world’s largest holder of foreign exchange reserves at $1.5 trillion at the end 2007. China’s economy continues to be a concern to many U.S. policymakers. On the one hand, U.S. consumers, exporters, and investors have greatly benefited from China’s rapid economic and trade growth. On the other hand, the surge in Chinese exports to the United States has put competitive pressures on various U.S. industries. Many U.S. policymakers have argued that China often does not play by the rules when it comes to trade and they have called for greater efforts to pressure China

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Mary Jo Devaland

to fully implement its World Trade Organization (WTO) commitments and to change various economic policies deemed harmful to U.S. economic interests, such as its currency policy, its use of subsidies to support state-owned firms, trade and investment barriers to U.S. goods and services, and failure to ensure the safety of its exports to the United States. Concerns have also been raised over China’s rising demand for energy and raw materials, its impact on world prices for such commodities, increased pollution levels, and efforts China has made to invest in energy and raw materials around the world, including countries (such as Iran, North Korea, and Sudan) where the United States has political and human rights concerns. This book provides an overview of China’s economic development, challenges China faces to maintain growth, and the implications of China’s rise as a major economic power for the United States.

Chapter 1

CHINA’S GROWING DEMAND FOR OIL AND ITS IMPACT ON U.S. PETROLEUM MARKETS* Congressional Budget Office Strong economic growth in Asia, particularly in China, has had a significant impact on global markets in recent years, including the markets for crude oil and refined petroleum products. This Congressional Budget Office (CBO) paper reviews major developments in China’s demand for crude oil and refined petroleum products over the past decade and considers the implications of those changes for motor fuel prices in the United States through 2010. The paper was prepared in response to a request from the Ranking Member of the Senate Committee on Energy and Natural Resources. In keeping with CBO’s mandate to provide objective, impartial analysis, the paper makes no recommendations. China’s demand for crude oil and refined petro leum products has been growing over the past decade, and in 2003 and 2004, the country’s demand for oil increased dramatically (see Figure 1-1), surprising many energy analysts. This paper explores the reasons for that growth and the implications for petroleum markets in the United States. World oil prices have been rising since 2004, driven in part by the increases in China’s demand for crude oil and refined petroleum products. Those increases were most prominent for the light petroleum products—gasoline and diesel—that are used primarily for transportation. *

This is an edited, reformatted and augmented version of a Congressional Budget Office paper, dated April 2006.

2

Congressional Budget Office

Over the next five years, the pace of growth in China’s demand for oil in general, and for transportation fuels in particular, could be a key factor contributing to further increases in the prices for crude oil and refined petroleum products. In the United States, those price increases could affect the demand for petroleum and influence the investment decisions of U.S. refiners.

Figure 1.1

The demand for petroleum has increased recently in other regions as well— including the United States, Middle Eastern nations, and other Asian nations— which has contributed to the higher prices. But those other markets—which are better understood than the Chinese market—are not as likely as China is to register continuing large increases in their demand for petroleum over the next five years. A better understanding of the growing Chinese market may be difficult to come by because the Chinese economy overall is growing rapidly, economic sectors are growing at various rates, and Chinese economic data, while improving, are less reliable than those available for the United States, Europe, and Japan. Much of the analysis in this paper makes use of official Chinese data on petroleum markets and the economic and social drivers of petroleum demand—

China’s Growing Demand for Oil …

3

and even the data on China taken from other sources ultimately rely on those official statistics. In recent months, Chinese authorities have announced large revisions to their data on gross domestic product (GDP), which have raised questions about the quality of that data and the relationship between economic output and energy consumption. Despite those questions, the Congressional Budget Office (CBO) finds the quality of the statistics sufficiently reliable for the purposes of this analysis.

REASONS FOR CHINA’S GROWING DEMAND FOR PETROLEUM China’s changing petroleum requirements are closely related to its high rates of growth in economic output and personal incomes. The growth in incomes and the accompanying changes in petroleum demand are themselves driven by an ongoing population shift from rural to urban areas. That growing urban population is demanding new vehicles and new roads, raising the demand for energy in the transportation sector (see Figure 1-2). Separately, the growth in output in the industrial sector is driving the high demand for petrochemical feedstocks, including naphtha-based petrochemicals, which are similar in composition to motor gasoline. Those underlying factors suggest a significant momentum in China’s demand for petroleum. A key concern in this analysis is not whether China’s demand for petroleum will continue to grow—as it undoubtedly will—but how fast it will grow over the next five years.

TWO SCENARIOS OF FUTURE DEMAND GROWTH IN CHINA To help explain how China’s oil consumption may change over the next five years, this paper presents two scenarios that encompass some of the major uncertainties underlying demand growth. The scenario of slower growth in demand is based on recent forecasts from several government and private organizations, and the scenario of faster growth in demand extrapolates from recent higher-growth trends. Each scenario has its own assumptions and implications (see Table 1-1).

4


Figure 1-2.

Table 1-1. Implications and Assumptions of CBO’s Scenarios for Slower and Faster Growth in China’s Demand for Oil


5

In the slower-growth scenario, CBO assumes that growth in Chinese oil consumption will average 4.5 percent a year through 2010—or approximately the average growth from the published forecasts reviewed in this paper. That rate, which is half the average growth rate of 9 percent experienced in 2003 and 2004, would be consistent with several factors: some slowing in demand in response to the near doubling of worldwide oil prices since early 2004, a reduction in the temporarily high demand for oil to generate electricity, and several policy initiatives in China that are intended to slow the growth in energy demand. In the faster-growth scenario, CBO considers the consequences if China’s petroleum use continued to grow at the high average pace of the past decade—or about 7.5 percent a year. That rate would be consistent with continued high growth in Chinese incomes, urban employment, vehicle sales, and highway construction. In both scenarios, most of the growth in China’s oil demand through 2010 is assumed to be in the form of light petroleum products—including motor fuels and some petrochemicals—which is consistent with other forecasts and recent trends.

CONSEQUENCES OF SLOWER AND FASTER GROWTH IN DEMAND In the near term, both scenarios of demand growth in China are likely to affect U.S. oil markets by causing higher crude oil prices, higher costs to refine that oil, and greater price volatility. The combined changes in crude oil costs and costs of refining could add from about 19 cents to 38 cents to the cost of a gallon of gasoline or diesel fuel in the United States in the next five years (in 2005 dollars). The biggest part of those potential increases would result from higher prices for crude oil. The scenarios about future growth in Chinese demand could lead to increased crude oil costs that, by themselves, would result in gasoline prices that were 16 cents to 33 cents a gallon higher than what they would be otherwise. If worldwide oil supplies were more responsive to increased oil prices than is generally assumed to be the case (an assumption underlying several published forecasts of oil prices), then the impact of higher Chinese demand on prices could be smaller than the estimates given here. Conversely, if the recent restraints on oil production in Saudi Arabia, Russia, and elsewhere did not loosen, the effect of

6


higher demand on prices could be greater yet. Those sensitivities for worldwide supply conditions are discussed but not evaluated in this paper. Another factor contributing to potentially higher motor fuel prices in the United States would be higher worldwide costs of refining crude oil. Those costs could rise over the next five years because of the increasing relative demand within China for motor fuels and naphtha-based petrochemicals, light products that are especially costly to produce from crude oil because they require additional equipment for processing and handling. (Alternatively, refiners can at higher cost acquire more of the premium-grade crude oils that can be more easily refined into light products.) Those additional costs for petroleum refining could further boost the prices for gasoline and diesel fuel in the United States by nearly three cents a gallon in CBO’s slower-growth scenario or about five cents a gallon in its fastergrowth scenario (in 2005 dollars). Those impacts assume that China’s policies guiding how much and what kind of refinery capacity to build do not significantly distort worldwide trade patterns. The two scenarios examined in this paper do not span the full range of possible outcomes. Demand growth in China could turn out to be below that envisioned in CBO’s slower-growth scenario (as, from preliminary data, appears to have been the case in 2005) or above that estimated in CBO’s faster-growth scenario (as it was in 2003 and 2004). In neither case are the consequences of China’s growing energy demand likely to appreciably dampen U.S. oil use or economic growth. Moreover, there are likely to be net benefits to the U.S. economy from China’s economic growth and world trade activities that this analysis does not address. China’s petroleum markets have undergone profound changes in the past decade as demand for a wide range of petroleum products has grown much more rapidly than many analysts expected and as growth in the country’s domestic oil production has slowed sharply. The increase in demand for oil has been greatest in the country’s transportation and industrial sectors, causing the mix of products demanded in China to shift away from heavy fuel oil and toward lighter fuels— diesel, gasoline, and petrochemical feedstocks. Demand in the transportation sector in particular has been pushed by high growth in incomes and demographic changes that are expanding the potential population of drivers. Along with high levels of motor vehicle sales and highway construction, those changes are laying a groundwork for future demand growth. To help manage those changes, while complying with national policies to preserve energy independence and protect the environment, the Chinese government is restructuring its oil industry.


7

CHINA’S TOTAL PETROLEUM USE In 2004, China became the second largest consumer of petroleum, behind the United States. In that year, worldwide petroleum demand increased by 3.3 percent, more than twice the annual rate of increase over the past decade.1 Nearly 30 percent of that additional demand originated in China, where demand grew at an annual rate of 15 percent. In the first three quarters of 2005, growth in China’s demand slowed, but preliminary data for the fourth quarter indicate that growth has again accelerated. Because China now consumes so much oil—nearly 6.7 million barrels a day in 2004—even a modest percentage growth in petroleum demand translates into a great deal of new oil each year.

Figure 2-1. 1

Changes calculated from data on world oil consumption and prices reported in Department of Energy, Energy Information Administration, Monthly Energy Review, DOE/EIA-0025 (July 2005), Tables 9.1 and 11.2. Oil prices are the costs for U.S. refiners to acquire imported oil.

8


China first emerged as a net importer of crude oil in the early 1990s. The country was largely self-sufficient in oil resources until 1992 (see Figure 2-1 and Table A-1). Utilizing the resources of its western regions and coastal waters, China’s state-owned oil businesses had been able for many years to boost production in line with growing demand. But production growth slowed in the mid-1990s, and came close to a halt in 2004, with output at about 3.5 million barrels a day. By 2004, in little more than a decade, China’s net imports of petroleum (including crude oil and refined products) had increased to about 3.0 million barrels a day—compared with 11.9 million barrels a day imported by the United States.2

A SHIFT IN DEMAND TOWARD LIGHT PETROLEUM PRODUCTS The recent growth across sectors of the Chinese economy has not been even, and the result has been a major shift in the mix of petroleum products consumed in China. A decade ago, fuel oil (in particular, heavy fuel oil for steam boilers) was an important part of that demand mix. Since then, demand growth has come from motor fuels—diesel fuel and gasoline—and from petrochemical feedstocks, including naphtha and liquefied petroleum gases.3 Middle distillates are the most important petroleum products consumed in China today (by volume) and have experienced the most growth in recent years (see Figure 2-2 and Table A-2). “Middle distillates” in the Chinese data comprise diesel fuel, heating oil, kerosene, and jet fuel. Middle distillates and gasoline together—with diesel being the dominant fuel—accounted for over 60 percent of petroleum consumption in China in 2004. (By comparison, in the United States, gasoline is the dominant product, and middle distillates and gasoline together account for nearly 75 percent of total petroleum consumption.4) Much of the growth in petroleum consumption 2

Net imports are estimated as the difference between reported total consumption of petroleum products and domestic production of crude oil. Data on net imports are from British Petroleum, Statistical Review of World Energy (June 2005). Data on changes in petroleum inventories in China are generally not available. If additions to stocks were positive in 2004, as is likely, imports for that year could have been higher than what is reported here. 3 The shift away from heavy fuel consumption may be greater than even those data indicate, since some heavy fuel oil reportedly is processed by petroleum refineries as a substitute for crude oil, not burned as fuel. 4 Calculated from data on annual petroleum consumption in 2004 from Department of Energy, Energy Information Administration, Monthly Energy Review, Tables 3.1b, 3.4, 3.5, and 3.7. For consistency with Chinese data, “middle distillates” include distillates and kerosene-type jet fuel.


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and the relative growth of particular fuels can be traced directly to growth in output of the major sectors of the Chinese economy—industrial, transportation, residential, and commercial. Changes in the efficiency of energy use in different sectors, which also can help to explain consumption trends, are less important than total economic activity in the short run.

Figure 2.2

Activity in the industrial and transportation sectors, which together account for over 80 percent of all petroleum use in China, explains much of the increase in demand for diesel fuel and gasoline. In 2002, the industrial sector accounted for over half of China’s total demand for petroleum (see Figure 2-3 and Table A-3). That sector includes manufacturing, agriculture, and energy conversion activities, such as petroleum refining and electricity production (see Table A-4). Manufacturing concerns—many of them involving foreign investors from the United States, Japan, and South Asia—use refined petroleum products such as heavy oil and diesel fuel to operate equipment and to heat and cool their facilities and use products such as naphtha and liquified petroleum gases to produce petrochemicals. In agriculture, petroleum demand is strongest for diesel fuel, which is used to power China’s 15 million tractors and 22 million small rural vehicles. The bulk of China’s electricity comes from coal, hydroelectric power, and nuclear power, but limits on the ability to rapidly expand that capacity in the

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face of recent growth in electricity demand have steered increased usage to older power plants burning heavy fuel oil and newer small-scale generators burning diesel fuel. As with petroleum demand in general, industrial demand is growing fastest in China’s urban centers. About 25 percent of China’s petroleum consumption is for transportation, including moving passengers and freight by road, water, rail, and air.5 The growing demand in the transportation sector reflects the new personal wealth in China, as well as the transport requirements of industrial and commercial activity in the urban centers of the eastern provinces. The major fuels for transport are diesel, gasoline, heavy oil (used as bunker fuel in shipping), and jet fuel. Diesel is by far the most important, accounting for nearly twice as much consumption as gasoline.

Figure 2.3

KEY DETERMINANTS OF MOTOR FUEL USE The key factors pushing the demand for oil in the transportation sector in China are the rising incomes of workers and the growing numbers of workers 5

For background information on the rise of China’s transportation sector, see Lee Schipper and WeiShiuen Ng, “Rapid Motorization in China,” World Resources Institute, October 18, 2004 (a paper commissioned for the ADB-JBIC-World Bank East Asia and Pacific Infrastructure Flagship Study), available at www.cleanairnet.org/asia/1412/articles-60209_china.pdf.


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living in big cities. The cities are where the jobs requiring increased road travel are and where the road infrastructure supporting that travel is being built. That growing transportation infrastructure in turn supports further economic growth and attracts migrants to the cities. Signs of high activity in China’s transportation sector include increases in per capita income, urban populations (and potential driver populations), vehicle sales, and highway construction.

Figure 2-4.

Growth in incomes in China and in the size of the potential driving population has exceeded growth in the Chinese economy. Although real GDP growth in China has averaged about 9.2 percent annually since 1990, the per capita incomes of urban households grew by 13.3 percent over that same period (see Figure 2-4 and Table A-5). Moreover, although the Chinese authorities do not report data on inflation-adjusted incomes, separate data on consumer prices in China indicate that prices have fallen in the past decade, suggesting that the increase in real per capita incomes was even higher than 13.3 percent.6 (Those statistics predate the 6

In the decade from 1994 to 2003, China’s consumer price index declined by nearly 20 percent, from 124.1 to 101.2. See National Bureau of Statistics of China, China Statistical Yearbook 2004

12


upward revisions to Chinese data on GDP and growth in December 2005—as do all the data on energy consumption and sectoral activity that were used for this report.) Because of the large shift in China’s population from the rural areas to the cities, the number of potential drivers has been growing rapidly. From 1990 to 2003, as China’s total population expanded by about 149 million, migration from the countryside helped the urban population to grow by nearly 220 million (see Table A-6). The migration to the cities is all the more important for transportation demand because the employment levels and average incomes of city dwellers have been growing relative to the levels for dwellers in rural areas. Urban employment grew by 3.1 percent a year over the 1990-2003 period, compared with a growth rate for the total population of only 0.9 percent. From some accounts, it appears that even more people are moving into the urban labor force than the total number moving to the cities would indicate—for example, as more women enter the paid workforce and as people shift from working for stateoperated businesses in which they had been largely underemployed. Within those high-income urban areas, the sector of the Chinese population ages 15 to 64—the prime age for being drivers—grew by 170 million, or about 4.7 percent a year. With the impetus from migration, employment, and earnings, the number of licensed drivers in China grew by nearly 90 million over the 1990-2003 period, or by more than 14 percent a year (see Figure 2-5 and Table A-6). That is, the rate of growth in the number of licensed drivers in China is more than four times the rate for employed urban people (the potential population of drivers), underscoring the consequences for transportation demand of the country’s economic expansion. (By way of comparison, the number of drivers in the United States in 2003 totaled 196 million.7) The transportation requirements of the labor force (for commuting, business travel, and intracity and intercity road freight) and the means afforded by their increased incomes are, in turn, reflected in the growing demand for motor vehicles (see Figure 2-6 and Tables A-7 and A-8). In 2003, there were nearly 24 million vehicles available for civil uses, including about 15 million passenger vehicles (cars and buses) and 9 million trucks. That total number was up from about 5.5 million vehicles in 1990, indicating average annual growth over those years of 11 percent. A growing share of the country’s motor vehicles are privately owned, too—including over 8 million cars and nearly 4 million trucks in 2003. (Vehicles owned by governments and businesses—mainly fleet vehicles and some vehicles (Beijing: China Statistics Press, September 22, 2004), Table 9-5. The average price declines in urban and rural areas were similar.


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assigned for personal use—account for most of the rest of the stock.) Annual sales of new cars and trucks in 2003 were about 4.3 million.

Figure 2-5.

7

Federal Highway Administration, Federal Highway Statistics 2003 (November 2004).

14

Figure 2.6



15

On top of those numbers—and often overlooked by studies of transportation demand in China—are government data indicating that there are 71 million motorcycles and other small off-road vehicles, with annual sales of over 13 million (despite government efforts to discourage their use in large cities). By way of comparison, there were 231 million motor vehicles registered in the United States in 2003, including only about 5 million motorcycles.8 Other vehicles in China include a large number of agricultural vehicles that can be used on roads (with over 8 million “tire” tractors in 2001, the last year for which data are available). And research suggests that the number of rural vehicles (small threeand four-wheeled diesel-powered vehicles manufactured for use in small cities and rural areas) may be as high as 22 million—although those vehicles may be grouped with “motorcycles” in government statistics.9 In conjunction with growth in the driving population and vehicle stock, China is spending nearly $29 billion annually on new highway construction and expansion.10 In 2003, the full highway system—not just expressways and firstclass highways—grew by 28,000 miles, and all highways and expressways in China extended for 1.1 million miles (see Table A-9). Over the 1990-2003 period, China’s highway system grew by 4.4 percent annually. And by 2000, over 98 percent of China’s towns and townships had highway connections.11 Because much of that investment removed local bottlenecks and helped to reduce travel times, the actual capacity of the highway system to move people and freight was increasing even faster than the number of lane-miles. (In comparison, the U.S. National Highway System comprises about 162,000 miles, including 47,000 miles of interstate highways.12 The total U.S. system, including state highways, extends for about 4 million miles.) Much of China’s highway infrastructure is concentrated in the coastal provinces that include the country’s largest cities—the same regions that are experiencing high growth in population and employment (see Table A-9). That is the area from 8 9

Federal Highway Administration, “State Motor-Vehicle Registrations—2003” (October 2004), available at www.fhwa.dot.gov/policy/ohim/hs03/htm/mv1.htm.

The estimate of the number of rural vehicles comes from Dan Sperling, Zhenhong Lin, and Peter Hamilton, “Chinese Rural Vehicles: An Explanatory Analysis of Technology, Economics, Industrial Organization, Energy Use, Emissions, and Policy,” Institute of

Transportation Studies, UCD-ITSRR-04-01 (2004). Estimated by the Congressional Budget Office from the 241 billion yuan (nominal) reported for new highway construction and highway expansion in the Chinese Statistical Yearbook 2004, Table 6-9, using an exchange rate in that year of 8.28 yuan per U.S. dollar. The exchange rate in late 2005 was about 8.10 yuan per dollar. 11 China News and Report, “Development of China’s Transport Network,” June 2001. 12 Federal Highway Administration, Federal Highway Statistics 2003. 10

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Guangdong province in the south (on the mainland, near Hong Kong) to Liaoning province in the north (above Beijing). Of the nation’s total 37,000 miles of expressways and first-class highways at the end of 2003, nearly 60 percent of those miles were in those coastal provinces and the large coastal cities of Shanghai, Beijing, and Tianjin.

THE CHANGING STRUCTURE OF THE CHINESE OIL INDUSTRY Three state-owned companies dominate all stages of the petroleum industry in China (see Box 2-1).13 CNPC (the China National Petroleum Corporation) is a vertically integrated business, involved in oil and gas production, refining, pipelines, and retail outlets. It generally operates in the North and West of the country. A CNPC subsidiary, PetroChina, is the country’s largest producer of oil

13

For background information, see Melissa Murphy, “An Overview of China’s Energy Sector,” Freeman Briefings, Center for Strategic and International Studies (November 2004).


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and gas from onshore regions, and it operates China’s largest pipeline complex. CNPC also holds oil and gas assets worldwide. Sinopec (the China Petroleum and Chemical Corporation) is a second vertically integrated business, involved in oil and gas production, refining, pipelines, and retail outlets. Generally operating in the South and East of the country, Sinopec is China’s largest petroleum refiner and largest retailer of petroleum products. The company produces crude oil domestically but imports most of the oil it refines. Like CNPC, Sinopec also holds oil and gas assets worldwide. Together, the two companies control 95 percent of the petroleum refinery capacity in the country. The third large company—CNOOC (the China National Offshore Oil Corporation)—is involved in the production of oil and gas, liquefied natural gas, and petrochemicals.14 It is the largest producer of oil and gas in China’s offshore areas, it operates China’s largest petrochemical complex, and it holds oil and gas resources throughout the Pacific and in Southwest Asia. The government has a direct stake in the financial performance of all of those businesses. In addition to taxes on income, the government receives a share of the profits from those businesses (it holds a majority of the shares in each one). Government interests are behind the industry’s push to develop oil resources in countries around the world. By providing low-cost capital and a supportive foreign policy, the government has enabled the national oil companies to sign long-term supply contracts, establish equity positions in foreign oil developments, and establish bilateral trade with those potential suppliers. Moreover, as stated in a directive, the government intends to consolidate the nation’s oil businesses into a handful of large, leaner companies (shedding excess capacity and employees) capable of pooling technical resources and competing directly with the largest international oil companies. The Chinese government has also sought to restructure its oil industry in other ways. In response to recent concerns about growing oil demand and oil imports, it has implemented efforts to make businesses more energyefficient, diversify the sources of energy supply, and curb growth in oil demand. In the “upstream” sector of the oil business (crude oil production), securing access to crude oil abroad is part of the government’s broad strategy to diversify the country’s sources of energy. That strategy includes the construction of oil and 14

In 2005, CNOOC made a bid to acquire the U.S. firm Unocal.

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natural gas pipelines from Kazakhstan and Russia and the construction of new port facilities for the importation of liquified natural gas—as well as efforts to promote the development of alternative fuels. The effort to improve efficiency and profitability has driven a major consolidation of businesses and an opening of oil and gas activities to foreign investment.15 In the “downstream” sector (refining and distribution), concerns about the technical inefficiency of many small companies and about air quality have led to further consolidation in ownership. One result was the closure of many of the smallest refineries. A related potential motivation for the restructuring was the opening of the petroleum industry and other industries to direct foreign investment, as required by China’s accession to the World Trade Organization. China’s refinery businesses have been opened to foreign investment on several occasions to help provide financing and technical expertise for the effort to expand capacity. The industry, however, is not yet fully open to foreign capital. For example, the government has stipulated that only CNPC and Sinopec can open new retail outlets, so foreign investors must partner with those firms to gain entry to the motor fuel market.

GOVERNMENT PROGRAMS THAT AFFECT THE DEMAND FOR PETROLEUM Further change in China’s oil markets is coming from regulations and programs to improve environmental quality and constrain growth in oil consumption. Noteworthy among the conservation efforts is the recent program to establish fuel economy standards for new motor vehicles. Other programs that have the potential to affect oil use are price controls on petroleum products and taxes affecting the cost of vehicle ownership and use. The actual effect of those programs is unclear. For example, fuel economy standards are unlikely to have much impact in the near term, since new cars can only affect the average fuel economy of all vehicles over time. Retail price controls on motor fuels, which in the short run could encourage gasoline use, have 15

For a discussion of foreign investment in China’s crude oil production and refinery industries, see Department of Energy, Energy Information Administration, Privatization and the Globalization of Energy Markets (October 1996), Chapter 4; and the Organization for Economic Cooperation and Development, Foreign Direct Investment and Importance of the “Go West” Strategy in China’s Energy Sector (Paris: OECD, March 2002). A discussion from the Chinese perspective appears in China E-News, “China Slowly Reforming Refineries and Petchem Industry,” available at www.pnl.gov/china/sinopec.htm.


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been eased. And motor fuel taxes that may appear low by international standards—and which, on their own, would seem not to discourage oil use—do not appear so low when all types of taxes on transportation are considered. As a general caveat to this discussion of government programs, there are concerns about how well China, as a still-developing country, is able to enforce those programs. In particular, institutional problems could cause fuel economy standards or other environmental policies to fall short of the government’s stated goals.

Environmental Regulation Urbanization, motor vehicle use, and industrial activity tend to degrade air and water quality in China. New environmental programs targeting emissions and waste disposal are responsible for the growing adoption of clean technologies and practices in all sectors of the petroleum industry—although the success of those relatively recent efforts cannot yet be assessed. The government’s efforts to consolidate ownership in petroleum refining and fossil fuel production in China was motivated in part by the interest in closing down small unregulated businesses that were contributing to environmental problems. Among the changes that could specifically affect petroleum refinery operations are new laws to eliminate lead from gasoline and restrict the sulfur content of gasoline and diesel fuel.

Fuel Economy Standards China’s fuel economy standards for new vehicles began in 2005, with a second, more-stringent, phase taking effect in 2008. The weight-based standards impose separate minimum requirements for fuel efficiency on 16 different classes of vehicles, ranging from 38 miles per gallon (mpg) for the lightest vehicles to 19 mpg for the heaviest. (In 2008, the requirements increase to 43 mpg and 21 mpg, respectively.) The biggest improvements would be required of the heaviest vehicles.16 16

For a description of China’s fuel economy standards, see Amanda Sauer and Fred Wellington, “Taking the High (Fuel Economy) Road—What Do the New Chinese Fuel Economy Standards Mean for Foreign Automakers?” (Washington, D.C.: World Resources Institute, November 2004).

20


Price Controls Expressed in U.S. dollars, gasoline and diesel prices in China are much lower than in other countries. Until recently, China’s system of price controls shielded Chinese consumers from the price of oil in world markets. The controls originally based prices for refined petroleum products on average costs to the oil companies—costs that included the controlled price for domestic crude oil. The effect of those controls was to convey a subsidy from producers to consumers of refined products. In 2001, however, Chinese policymakers began moving away from price controls on energy products by tying retail prices for gasoline and diesel to a weighted average of futures prices for those commodities in Singapore, Rotterdam, and New York.17 The government—specifically, the National Development and Reform Commission, or NDRC—establishes a national benchmark for retail prices for all but the largest petroleum marketers. The government allows Sinopec and CNPC’s PetroChina to set their own retail prices, in accordance with the principle of revising prices only when foreign prices change. For smaller marketers, local governments have the immediate responsibility for carrying out the central government’s guidelines, with additional discretion to alter prices within a 5 percent band around the national benchmark. The NRDC was to revise those prices every few months, whenever wholesale prices moved by more than 8 percent, up or down. In March 2006, the commission adopted its first major price changes in eight months, increasing pump prices in Beijing to nearly $2.20 a gallon for premium grade gasoline and about $1.90 a gallon for diesel.18 With worldwide prices for crude oil and refined products rising steadily, the time lags in adjusting retail prices had created a periodic loss of profits for China’s refiners, prompting the most recent revision in prices. As a result of China’s policy changes, gasoline and diesel prices in China now tend to reflect the marginal costs of supplying those fuels over time, without conveying as significant a subsidy to petroleum consumers. But because prices still are not completely free to respond to market conditions, the current system may be responsible for some problems with investment and marketing. Unless time lags in adjusting retail prices are completely eliminated, there will be periodic incentives to export products if the benchmark price falls below the 17

A discussion of Chinese price controls and some of the problems associated with them appears in “Trend or Glitch,” Beijing Review (2005), available at www.bjreview.com.cn/En-2005/05-26e/bus-5.htm 18 China Daily, “Preparation Prevents Higher Oil Price Pain,” March 28, 2006, available at www.chinadaily.com.cn/opinion/2006-03/28/content_553748.htm. Prices in yuan per liter were converted to dollars per gallon using 0.264 liters per gallon and 8.10 yuan per dollar.


21

market value or to import them if the market value falls below the benchmark price. Prices that lag behind costs can undermine profitability and discourage domestic investment in refining and distribution capacity. Also, with a national benchmark, if prices are not completely free to vary across regions, profit incentives may not be sufficient to encourage suppliers to keep pace with demand in the fast-growing urban areas.

Energy Taxes Direct taxes on motor fuels in China are low, compared with the levels in most industrialized countries, but additional taxes on vehicle ownership and operation (including extensive road tolls) can add greatly to the cost of travel and influence decisions about the fuel economy of new vehicles. A full consideration of the effects of taxes on motor fuel consumption in China needs to consider all of those taxes. China’s transportation costs reflect the basic costs to oil businesses of several taxes assessed by the central government:

• • • •

A 17 percent value-added tax (or VAT, the main source of revenue for the central government), An income tax on large enterprises, A “consumption” tax on luxury items, and A vehicle purchase tax.

The VAT and the enterprise income tax are common to all businesses, with numerous exemptions or reductions depending on the product, the technology of production, the age of the operation, and the location of the activity. For example, China has a reduced VAT—13 percent—on sales of propane, natural gas, and residential energy services. And there are many free-trade zones and foreign firms producing for export that pay lower tax rates. The consumption tax, assessed on producers of gasoline and diesel, is the only direct tax per unit of fuel. Currently, that tax is fixed at 117.6 yuan per metric ton for gasoline (about six cents a gallon) and 277 yuan per ton for diesel (about 10.5 cents a gallon).19 The central government’s tax on vehicle purchases depends on the size of the engine, varying 19

Converted to cents per gallon using 8.53 42-gallon barrels of gasoline per metric ton, 7.46 42gallon barrels of diesel per metric ton, and 8.10 yuan per dollar.

22


from 3 percent for the smallest vehicles to 20 percent for the largest.20 Only the VAT and the consumption tax directly affect fuel prices and the current cost of travel. But the tax on vehicle purchases can indirectly affect the cost of travel over time by influencing buyers’ decisions about the fuel economy of new cars. Estimating the actual costs imposed by the VAT is difficult because an up-todate history for gasoline and diesel prices in China is not readily available. However, information on Beijing prices in March 2006 can help to clarify the impact of those taxes. With prices for premium grade gasoline at that time at 4.65 yuan per liter (or about $2.20 a gallon), the combined VAT and consumption tax included in that price was about 39 cents a gallon.21 For comparison, the average price in the United States in that month was about $2.50, including a combined federal and state tax on gasoline of about 44 cents, on average. (If growing crude oil costs were passed through to consumers or if the yuan was revalued—many analysts believe it is priced too low relative to the dollar—the Chinese tax in cents per gallon would increase.) Local Chinese governments also impose taxes and fees. Additional costs to consumers come from local assessments related to vehicle purchases, driver permits, vehicle licenses, and road maintenance fees, and from private tolls on expressways and bridges. Road maintenance fees and tolls, which together finance much of the country’s road construction, are especially costly. Almost all of China’s new expressways are toll roads.22 Road maintenance fees are assessed annually, generally on the basis of vehicle size—so that owners of larger, lessfuel-efficient vehicles have higher costs of ownership. It is not clear how much those local charges are costing Chinese drivers. But it is possible to get a general idea of the revenues required by looking at the country’s annual spending on highway construction (which the road maintenance fees and tolls finance) and its consumption of gasoline and diesel. An assessment equivalent to nearly $1 a gallon on gasoline and diesel fuel would be needed to fully fund China’s annual spending on highway construction of about $29 billion in 2003, assuming (for illustrative purposes) on-highway fuel use of about 2 million barrels a day.23 20

China Daily, “Buyers of Big Cars Have To Pay More Tax,” March 23, 2006, available at www.chinadaily.com.cn/china/2006-03/23/content_549959.htm. 21 Converted using the factors listed in footnote 17. 22 Alfred Nickesen and others, “Toll Road Securitization in China,” The World Bank Group, Roads & Highways Note RH-3 (February 2000). 23 In 2004, gasoline consumption in China was 1.6 million barrels a day, which was largely for road use. It is not known how much of diesel consumption was for road use. See British Petroleum, Statistical Review of World Energy.


23

SCENARIOS OF FUTURE DEMAND GROWTH IN CHINA This section examines two alternative scenarios of how rapidly the demand for petroleum in China will grow over the next five years. On the one hand, demand may be restrained by slower growth in the Chinese economy overall, high oil prices, an easing of some pressures that temporarily increased demand, and policies put in place by the Chinese government that may reduce petroleum consumption.24 On the other hand, demand may be accelerated by the reinforcing trends of growing urban populations and incomes and more vehicles and drivers with an expanding road system on which to travel. The growth in China’s total oil consumption in the next five years is important for the United States because any addition to worldwide oil demand could put upward pressure on worldwide oil prices. The economic circumstances that would make the faster-growth scenario feasible are perhaps of most interest to policymakers, since that scenario is associated with the largest increases in worldwide oil prices. But this paper does not present either scenario as more likely than the other. Circumstances may exist in which demand growth in China turns out to be below the slower-growth case (as, from preliminary data, appears to have happened in 2005) or above the faster-growth case (as happened in 2003 and 2004). In neither case are the consequences of China’s growing energy demand likely to appreciably dampen U.S. oil use or economic growth. Most likely, the net benefits to the U.S. economy from China’s economic growth and China’s contribution to the world’s economy—which this analysis does not address—will be positive. Furthermore, in neither scenario will the price for crude oil in 2010 necessarily be higher than it is today. Each of the forecast reports reviewed here projects a different path for prices, consistent with its views on the global growth CBO has no information on how the maintenance of roads in China is financed. Some of the toll collections could go toward that purpose. Maintenance in the United States is generally a local concern, funded in part by state motor fuel taxes. 24

Some analysts point to the possibility that new conservation policies, such as the promotion of alternative fuels and increased efficiency of buildings, could help to slow growth in demand. However, many of those policies are unlikely to yield significant savings in the next five years, so they are not considered in this analysis. For example, in one alternative scenario, the International Energy Agency discusses measures that might yield total oil savings of 13 percent by 2030. See International Energy Agency, World Energy Outlook 2004 (October 2004), pp. 391 and 393. Among the policies the IEA evaluated are new standards for fuel economy, plans for increased research and tax credits to promote the use of clean vehicles, and plans for expanding China’s intracity and intercity railway networks. For the other major forecasts of future energy demand in China, the potential contribution, if any, from recent conservation programs is not known.

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in worldwide oil demand, not just the growth in China, and the changes in worldwide oil supply. But regardless of where oil prices are headed—whether up or down—the additional demand from China alone will add something to that price. It is those price increments attributable to changes in the Chinese market that are of interest in this analysis.

MAJOR OIL MARKET FORECASTS Several government and private groups publish forecasts of worldwide energy use through 2010 and beyond. The reports examined here, all published in 2004 and 2005 and prepared before the final data for those years were available, come from the Energy Information Administration (EIA), the International Energy Agency (IEA), the International Monetary Fund (IMF), the Organization of Petroleum Exporting Countries (OPEC), and Global Insight (GI).25 (Updates to the IEA outlook were released in November 2005, but they exclude detailed forecasts for China. Other major studies of the worldwide energy market exist but are not publicly available—such as the Global Energy Watch by Cambridge Energy Research Associates.) The forecasts are in relatively close agreement on the prospect of continued high growth in the Chinese economy. All of the forecasts reflect a slowing in the growth of oil demand, with total oil consumption growing more slowly than overall economic output. But each forecast has demand for oil in the transportation sector growing faster than economic output—and, as a consequence, demand for oil in other sectors growing much more slowly. As a result, the forecasts show transportation fuels as accounting for an increasing share of total oil consumption in China. Recent mid-term forecasts of annual growth in China’s gross domestic product through 2010 span a range of 6.4 percent (from EIA and IEA) to 8 percent (from IMF) (see Table 3-1). The 8 percent figure from the International Monetary Fund matches the target established in China’s 11th Five-Year Plan, issued in 2006.26 It is likely that Chinese policies over the next five years will be oriented toward achieving growth 25

See Department of Energy, Energy Information Administration, International Energy Outlook 2005 (July 2005); International Energy Agency, World Energy Outlook 2004; International Monetary Fund, World Economic Outlook (April 2005); Organization of Petroleum Exporting Countries, Oil Outlook to 2025 (September 2004); and Global Insight, Global Petroleum Outlook (Winter 2004-2005). 26 See Government of the People’s Republic of China, 11th Five-Year Plan for National Economic and Social Development (March 2006). The plan covers the 2006-2010 period.


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that is at least that high. With China’s real GDP currently growing at close to 10 percent a year, even that 8 percent level would represent a significant slowdown from the trend of the past five years. (The historical growth rates for GDP that this paper cites were prepared before the statistical revisions announced by the Chinese government in December 2005.27 The revisions reflect new information on service-sector activity. As a consequence, in January 2006, the Chinese government increased its estimate of GDP growth in 2004 from 9.5 percent to 10.1 percent. The current estimate for growth in 2005 is 9.8 percent.) Table 3.1

Behind the projections of some slowing in economic growth is a view that China cannot continue its rapid pace of capital investment without risking inflation or stressing the country’s financial institutions. For those reasons, many analysts agree that China’s government will continue its efforts to restrain the pace of economic expansion. Moreover, China’s growing current-account surplus may exert upward pressure on the value of its currency. A stronger yuan would 27

The revisions were widely discussed in the press. See, for example, “China Says It Grew Faster Than First Thought,” New York Times, December 20, 2005, p. C4; and “China Raises Growth Figures for Recent Years,” Wall Street Journal, January 10, 2006, p. A12.

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decrease China’s net exports and help to moderate its GDP growth, at least in the short run. Table 3.2

In each forecast, growth in total oil consumption in China through 2010 is lower than the projected growth in GDP and below the growth in oil consumption over the past decade (see Tables 3-1 and 3-2). The forecast growth rates for China’s total oil use range from 3.5 percent a year (IEA) to 5.8 percent (EIA)— below the average growth of 7.5 percent a year from 1995 to 2004. The ratios of projected growth in total oil consumption to growth in GDP—described as the income elasticity of oil demand—range from 0.55 (IEA) to 0.91 (EIA).28 (For comparison, total oil consumption in the United States and other mature economies generally grows at about half the pace of the economy, reflecting an income elasticity of oil demand equal to about 0.5.29) 28

29

Those ratios summarize the short-term relationship between changes in oil use and economic output—or income. The additional effects of changing oil prices on demand are included in the

elasticity by way of their indirect effect on economic activity. The income elasticity for mature market economies was calculated from Department of Energy, Energy Information Administration, International Energy Outlook 2005, on the basis of growth in transportation oil use described in Table 3 and GDP growth described in Table A3. Separately, the International Monetary Fund assumes an income elasticity of demand for transportation fuels that is 0.32 for OECD countries and the newly industrialized Asian


27

Table 3.3

There is greater agreement among forecasters about the demand for oil in the transportation sector than about total oil use in China (see Table 3-3). The forecast growth in demand for oil consumed for transportation from 2004 to 2010 ranges from 6.0 percent a year (IEA) to 8.0 percent (OPEC). That compares with annual growth of 10.8 percent for oil consumption in China’s transportation sector over the past decade and 8.4 percent for consumption of gasoline and middle distillates, including uses of those fuels in other sectors (see Tables A-1 and A-3). In contrast economies and 0.85 for other non-OECD countries; see International Monetary Fund, World Economic Outlook, Table 4.3. In the past decade, oil consumption has grown at an average

28


to total oil use, consumption for transportation in those forecasts generally is projected to keep pace with growth in the overall economy through 2010. Combining the forecast results, the ratios of growth in transportation demand to growth in GDP range from about 0.93 (OPEC) to about 1.13 (EIA). (Some of the difference may be attributable to different concepts of consumption for transportation, relying variously on total energy, total oil, and total oil for road use.) Forecasts for the Chinese transportation sector reflect much higher growth than those for the U.S. transportation sector. Transportation demand in the United States (which dominates total U.S. oil demand) has been growing over the past decade at about 1.8 percent a year. That is half the rate of growth in the general economy (3.3 percent) but more than twice the rate of growth of the total population (0.8 percent). Complementing the published forecasts of high growth in transportation use are generally low forecasts for growth in oil consumption by other sectors of the Chinese economy. The combined forecasts for oil consumed in the residential, commercial, and industrial sectors indicate annual growth through 2010 that ranges from 1.6 percent (OPEC) to 3.9 percent (EIA).30 Those rates show expansion in the demand for oil by homes and businesses (for space heating, machine operations, processing of raw materials, and so forth) that is from onefifth to one-half the rate of expansion in the general economy. The rates are slower than the 4.9 percent pace of growth for those sectors from 1995 to 2002 (the most recent year for which sectoral data are available) and the 6.4 percent growth for fuels other than gasoline and middle distillates from 1995 through 2004. The forecasts also indicate a general consensus that transportation fuels will make up an increasing share of the total mix of petroleum products consumed in China in the future. Whereas the forecasts for total oil demand are important for worldwide oil prices, the forecasts for the relative demand for transportation fuels are important for the future costs of refining petroleum products.

30

annual rate of 1.8 percent, while real GDP has grown at 3.3 percent. Total consumption by other sectors was estimated by subtracting transportation consumption from total consumption.


29

THE CASE FOR SLOWER GROWTH IN DEMAND The slower-demand-growth scenario presented here assumes that total Chinese oil use will continue to grow at the rates that had been projected in the reports by the government and private organizations reviewed in this paper. Taking the average of those forecasts, the growth in this scenario would be 4.5 percent a year, resulting in total oil demand by 2010 of about 8.5 million barrels a day—an increase of about 2 million barrels a day over the current level. Based on those forecasts and recent growth, most of that additional demand is expected to be for light petroleum products—especially motor fuels in the transportation sector. Consistent with that view, at the end of last year (before final data were available), growth in the demand for oil in 2005 indeed appears to have slowed. Based on data available through September 2005, IEA expects that China’s demand for oil in 2005 will be only about 2.9 percent higher than in the previous year.31 That scenario also is consistent with the view that the temporary market conditions of the past couple of years have eased and that new initiatives to restrain growth will succeed. Some support for that result comes from analyses concerned with structural weaknesses in China’s financial sector and with its ability to sustain high levels of capital investment in the near future.32

Demand Response to High Oil Prices The major forecasts reviewed here were prepared before the big increase in worldwide oil prices in 2005. Some change in demand in response to those increased prices may have contributed to a slowdown in the growth of oil consumption in China that year. If oil prices remain high or rise further, that dampening effect will probably continue. Consistent with the view that consumers may have responded to the sharp increases in petroleum prices by buying less gasoline, oil consumption in the United States in 2005 was flat, too—even before the gasoline price hikes that followed Hurricanes Katrina and Rita. It is difficult to assess precisely how demand will respond to changing prices in China. Prices for petroleum were controlled until 2001, so there has not been much statistical evidence of price and consumption changes to evaluate. 31 32

International Energy Agency, Oil Market Report (January 17, 2006), p. 4. An important discussion of that point appears in Morris Goldstein and Nicholas Lardy, “What Kind of Landing for the Chinese Economy?” Institute for International Economics, Policy Briefs in International Economics, No. PB04-7 (November 2004).

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Also, as discussed in this paper, so many other factors that determine the demand for oil were changing at the same time. In both the short and the long terms, prices are generally less important for predicting oil consumption than are population and income—both of which were adding to demand in China even as oil prices rose.

Reversal of Some Temporary Demand One circumstance that may have contributed to the high demand for oil of the past few years has been China’s problems in generating and delivering enough electricity to support its growing cities and industries. A part of that added demand may have been for heavy fuel oil, consumed by the electric utilities in central generating plants. (In 2002, utilities in China generated about 79 percent of their electricity from coal, 17 percent from hydropower, 2 percent from heavy fuel oil, and 2 percent from nuclear power.33) But, according to that explanation, problems with the reliability of the supply of electricity also caused many businesses and building owners to install small diesel-powered generators of their own—known as distributed generation—to meet their individual needs. So as the country continued to add central generating plants (largely powered by coal and nuclear energy) and to expand the transmission and distribution networks in 2005, some of the demand for diesel fuel would have eased. It is difficult to know to what extent a shift toward distributed generation has increased the demand for diesel fuel in China. The electricity produced by those small diesel-powered generators is not counted with the data on the electricity sector, and whatever diesel fuel is used for that purpose is included (but not distinguished) in the total fuel consumed by manufacturing, commercial businesses, and residences. However, it is known that the consumption of middle distillates (including diesel) and heavy fuel oil each grew by an average of 15 percent a year in 2003 and 2004, compared with annual growth for gasoline of about 10 percent in the same period. As a first approximation, if diesel consumption for transportation had been growing at the same 10 percent pace as gasoline consumption, then some of the additional demand for middle distillates could have been for diesel to use in distributed generators. That possibility points to a maximum increment of diesel demand for power generation in 2004 and 2005

33

Based on 2002 data from the National Bureau of Statistics of China, China Statistical Yearbook 2004 (Beijing: China Statistics Press, September 22, 2004), Tables 7-4, 7-5, and 7-6.


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combined of only about 0.20 million barrels a day—or less than 4 percent of China’s total oil use.

Government Efforts to Restrict Consumer Credit and New Car Sales Another factor that may contribute to a slowdown in oil use relates to efforts by the Chinese government beginning in 2004 to curb automobile sales through a general tightening of consumer credit. The effects would be somewhat limited because a big part of vehicle sales is to state-owned businesses and government agencies, not to individuals. Those sales would more likely depend on the size of government- and state-owned businesses’ budgets than on credit conditions. (Those cars and trucks are classified as “transport vehicles” in the Chinese transportation statistics, as distinct from “privately owned” vehicles; see Table A7.) Moreover, it has been reported that only 1 in 10 car sales to private parties is financed by loans.34 Higher interest rates notwithstanding, separate changes in lending practices in China that are reducing the cost and time necessary for making loans are likely to increase car sales over the next five years. In particular, foreign automakers in China are working to create the financial information systems that will help them confirm credit histories for individuals and speed up the process of making personal loans. Consistent with those developments, “passenger cars for private use” is the fastest growing category of vehicle sales in China.

New Fuel Economy Standards and Easing of Limits on Small Car Use China’s central government recently initiated a program to raise the fuel economy of new passenger vehicles. And, in a separate action, it directed local governments to lift a number of local restrictions on the use of small cars in cities. The goal of China’s new standards for automobile fuel efficiency, commencing in 2005 and ratcheting up in 2008, is to curb the growth in motor fuel consumption. That program could save some oil, but it is important to recognize its limitations in the short term. According to the World Resources 34

Shai Oster, “DaimlerChrysler Offers Financing in China,” Washington Post, November 2, 2005, p. D5.

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Institute, only 66 percent of the cars sold in China in 2004 would meet the 2005 standards, and only 4 percent of the SUVs and minivans sold in 2004 would meet those standards. The impact of the program would be further limited in the next five years because fuel savings can only grow with cumulative vehicle sales of more-efficient vehicles. Moreover, some analysts have raised questions about the effectiveness of the standards, and any fuel savings could be even smaller than policymakers might expect. In particular, the program is likely to face the same problems as those seen in implementing corporate average fuel economy, or CAFE, standards in the United States.35 Commercial vehicles and light trucks in China are not subject to the fuel economy standards, and there is nothing to keep the mix of vehicles from shifting toward the heavier, less-efficient models. In the United States, the average fuel economy of new vehicles has been declining since 1987, because the standard for light trucks is lower than that for passenger cars and automakers have been able to produce more SUVs and vans—vehicles that are classified as light trucks but that compete directly with passenger cars. With 16 classes of vehicles in China’s program, that type of shifting between models may be even easier. The standards are stringent, however, and the biggest improvements will be required of the heaviest vehicles covered by the program. Beginning in March 2006, the government also has eased restrictions on the use of the smallest vehicles in certain urban areas.36 Many of those vehicles—with engine sizes of 1 liter or less—had until then been banned from more than 80 cities because of unsafe designs and local government concerns about the possibility that great numbers of very small vehicles—like bicycles a few years ago—projected an image of low economic development. With design improvements, some of those concerns have eased. This change could promote sales of these mainly Chinese-made vehicles as well as improve average fuel economy. However, it is not known whether that policy change is simply acknowledging the existing popularity of such vehicles or what fuel savings could result.

35

For background information on the U.S. program, see Congressional Budget Office, The Economic Costs of Fuel Economy Standards Versus a Gasoline Tax (December 2003). 36 See “China to Remove Restrictions on Smallest Cars,” Wall Street Journal, January 5, 2006, p. A12.


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Possible Future Increases in Fuel Taxes China currently is debating whether to impose a national fuel tax in its effort to consolidate and streamline the collection and management of the government revenues related to vehicle ownership and use. Proponents of such a tax point to the potential benefits from reduced fuel consumption. Unlike policy measures that restrict vehicle sales or call for improved fuel economy, the full impact of a fuel tax could be immediate. Without knowing the details of a new tax, however, determining the impact on demand for motor fuels is not possible. Aside from the fact that demand for gasoline and diesel fuel in general is not very responsive to small changes in price—especially in China, where so many vehicles are state-owned—there are many questions about how effectively such a tax could be implemented. One question concerns exemptions. If the fuel consumed by agricultural vehicles was exempt—as it is in the United States—then the impact of the tax would be small, because the exemption would apply to millions of small rural vehicles in the Chinese countryside that use diesel fuel for road travel. Moreover, if such a tax only replaced road maintenance fees (a variable cost of travel), the ultimate effect on the total cost of driving might be nil.

THE CASE FOR FASTER GROWTH IN DEMAND The faster-demand-growth scenario assumes that total Chinese oil use will continue to grow at the past decade’s average pace of about 7.5 percent a year, with total oil demand by 2010 of just over 10 million barrels a day, or about 4 million barrels a day higher than China’s consumption in 2004. Underlying this construct is the idea that the structural changes under way in China will persist— specifically, that rising urban populations and incomes will continue to push up the numbers of drivers and vehicles using an expanding road system—and will result in greater consumption of transportation fuel. Faster growth would require that those factors not be significantly altered in the near term by business downturns or dampened by the Chinese government’s efforts to rein in economic growth and inflation by restricting consumer demand and investment. Consistent with recent trends in the basic determinants of petroleum demand and with recent demand growth, most of that additional

34


demand is assumed to be for light products—including motor fuels in the transportation sector and diesel fuel and petrochemicals in the industrial sector.37 Despite the sustained high growth in oil consumption over the past decade, continued growth is not certain. In 2005, preliminary data on oil consumption indicated slowing growth into the fall. However, the early indicators at year’s end were that growth would return to the rates experienced in 2003 and 2004. In September 2005, total oil consumption was growing at an annual pace of 8.6 percent, gasoline consumption at 14.4 percent, and new car sales at 31 percent.38

Income Growth Some analysts believe that the Chinese government will not be successful in restraining capital spending and export growth, in which case the continuation of high growth in output and personal income—and oil consumption—would be likely. As a matter of political concern in China, future economic expansion may be necessary to prevent unemployment from rising as the influx of people to the cities continues. Not surprisingly, a number of economists not directly involved with energy forecasting support an outlook for continued economic growth—at the rate of 8 percent or higher—in China.39 But the faster-growth scenario could hold true even if demand for oil in the residential, commercial, and industrial sectors was to lag, because continued high growth in the transportation sector is likely.

Migration to the Cities The potential population of drivers and general economic activity, which are key determinants of motor fuel demand, have been growing in China at a pace 37

In contrast, the slower-growth scenario assumes that all of the increase is for the light products consumed in the transportation sector, consistent with forecasts that indicated relatively weak growth in nontransportation sectors of the economy. The fastergrowth scenario assumes that demand for diesel and petrochemicals in the industrial sector will be part of the total demand growth through 2010. However, for the purposes of estimating the impact of the growing demand for light products on refineries’ costs, this analysis assumes that the relative mix of transportation fuels and light industrial fuels and feedstocks does not matter. 38 International Energy Agency, Oil Market Report (November 10, 2005), p. 11. 39 For example, see Michael Mussa, “Global Economic Prospects: Slower But Still Solid Growth in 2005; Worries About Growth and Inflation for 2006,” Institute for International Economics (April 2005), available at www.iie.com/publications/papers/mussa0405.pdf.


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greater than motor fuel use. The continuing steady growth in the urban population and urban employment in China give further impetus to the idea that high growth in transportation demand is likely to persist (see Tables A-5 and A-6). The fastergrowth scenario suggests that much of the new demand for motor fuels is closely related to changing demographics that will add to the demand for transportation fuel, independently of the pace of overall economic activity. The migration to the cities and the social changes that are increasing the relative numbers of individuals of prime age in the population both have great momentum. The thrust of Chinese policy is to accommodate that movement by providing employment and housing opportunities rather than acting to slow the growth of the cities. No studies reviewed by CBO suggest that the Chinese government will reverse the tide of people moving to the cities or that the age pyramid will be altered in the next few years. Further evidence for the potential for continued migration may come from a comparison with urbanization in the United States. In the decade after 1900, when urban residents made up nearly 40 percent of the U.S. population, the urban population was growing at nearly twice the rate of the total population.40 In China’s most recent census (2000), the country’s urban population was up to a similar 35 percent of the total population, but the urban population was growing by 4.3 percent a year, or nearly four times the rate of growth for the total population.

The Growing Vehicle Stock The potential demand for motor fuels is most directly indicated by changes in the numbers of motor vehicles and licensed drivers. In recent years, the number of drivers in China has been growing faster than the overall stock of cars and trucks and faster yet than the demand for motor fuel (see Figure 1-2). The rate of growth in demand for vehicles appears to be increasing. Over the 2000-2003 period, annual growth in the number of passenger vehicles (including buses) averaged 13.7 percent, trucks averaged 4.4 percent, and motorcycles and other unregistered vehicles, 13.3 percent. Data on the composition of that stock, available only for 2003 and 2004, indicate that the number of the largest and the smallest vehicles registered for highway use was essentially unchanged. But the 40

U.S. population data for 1900 and 1910 are from Bureau of the Census, “Mini Historical Statistics: Population Characteristics (Sex, Race, Urban, Rural),” available at www.census.gov/ statab/www/minihs.html. Chinese population data for 1990 and 2000 are from the National Bureau of Statistics of China, China Statistical Yearbook 2004, Table 4-4.

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number of medium-sized and small cars (which account for three-fourths of all passenger vehicles) grew in that short period by nearly 27 percent, and the number of middle-sized and light trucks (which account for three-fourths of all trucks) grew by almost 10 percent. “Other” motor vehicles (mainly motorcycles) increased in 2004 by 15 percent, or 10 million units. Separate data indicate that annual motorcycle sales currently are over 13 million units and that the total number registered by the end of 2005 was going to be in the range of 95 million to 100 million.41 Many analysts expect growth in the country’s stock of passenger cars, trucks, motorcycles, and small rural vehicles to remain high. In one study, the sales of cars and trucks alone are forecast to grow from 4.4 million new units in 2003 to 7 million by 2010.42 At that higher level, China would be the second largest automobile market in the world (after the United States, but ahead of Japan). That private forecast is broadly consistent with the International Energy Agency’s outlook for the total stock of civil vehicles to grow by nearly 20 million in China from 2002 to 2010.43 Under an assumption of a 5 percent rate of attrition for old vehicles each year, those new sales would take the total car and truck stock from 23.8 million units in 2003 to 52 million in 2010. Some observers find support for growth in China’s current low levels of vehicle intensity per capita. In 2003, there were only about 11 registered passenger vehicles (including buses) and seven trucks per 1,000 people (see Tables A-5 and A-7 for data on population and vehicle stock, which were used to compute vehicle intensity). By 2010, with 0.5 percent population growth and a rate of sales that boosts the vehicle stock to 52 million units by that year, China would still have only 38 vehicles per 1,000 people. That projection compares with a 2003 rate of over 800 vehicles per 1,000 people in the United States, which includes nearly 500 automobiles per 1,000 people.44 Those small figures on vehicle concentrations may overstate the potential for future growth in vehicle ownership, travel, and, hence, fuel consumption. Despite relatively few cars, China has an extensive public transportation system, the number of motorcycles is large, and there are many small rural vehicles that are 41

Jialing, Inc., “China Rolls Out Motorcycles,” reprinted from the American Journal of Transportation (April 14, 2004), available at www.jialing.co.za/news%202.htm. 42 FOURIN China Auto Weekly, “2010 China Automotive Market Forecast,” available at www.fourin.com/chinaautoweekly/2010CAMF.html. 43 The IEA’s forecast of the vehicle stock in 2002 and 2010 comes from its World Energy Outlook 2004, Figure 8.13. Detailed data were confirmed in a private communication with the IEA’s Economics Analysis Division: 24.07 million vehicles in 2002, and 43.06 million in 2010.


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not counted in either the data on civil motor vehicles or motorcycles. Taxis and buses are reportedly used much more intensely than similar vehicles in the United States. Moreover, the current stock of vehicles is concentrated in the urban areas, where there were about 14 automobiles and 240 motorcycles per 1,000 households in 2003.45 In Beijing, the average was 66 automobiles per 1,000 households.

CONSEQUENCES FOR MOTOR FUEL MARKETS IN THE UNITED STATES This section examines the potential impact of China’s economic growth on future oil prices and oil refining costs according to the scenarios of slower and faster demand growth developed in the previous section. Over the next five years, the likely impacts of economic growth in China on oil markets in the United States all relate to prices: increased crude oil prices, greater costs to refine oil, and, as a result, higher prices for gasoline and diesel fuel. The combined changes in crude oil costs and costs to refine it could add a total of 19 cents to 38 cents to the cost of a gallon of gasoline or diesel fuel in the United States in the next five years (in 2005 dollars). The growing total demand for oil products in China will add pressure on worldwide crude oil prices over the next five years. And the growing relative demand for motor fuels and other light products within China will add pressure on costs to refine oil worldwide and in the United States. The potential for increased price volatility, attributable to China’s contribution to growing worldwide demand and increasingly tight market conditions, is addressed in this analysis but not estimated. The possible changes in worldwide oil prices over the next five years are calculated using an estimate of the price elasticity of the net supply of oil. Changes in costs to refine oil are calculated using the statistical relationship over the past decade between refinery margins and light product yields, and controlling for the effect of changing product inventories. The task of estimating the effects of China’s economic growth on oil prices is complicated because the markets for crude oil and motor fuels are world markets, which will also be affected by changes in oil demand and refinery investments elsewhere in the world. If the 44

U.S. vehicle statistics are from Federal Highway Administration, “State Motor-Vehicle Registrations—2003,” available at www.fhwa.dot.gov/policy/ohim/hs03/htm/mv1.htm. 45 See National Bureau of Statistics of China, China Statistical Yearbook 2004, Table 10-17.

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world oil supply is more responsive to price changes than assumed here, the effects on world prices of growing demand for oil in China will be smaller than what is shown. A number of additional factors bear on potential market effects. One is the policy choices that China will make about how much to invest in its domestic capacity for refining crude oil. Others are pressures on motor fuel prices that may come from changes in the environmental rules that affect product quality or refinery operations, changes in the quality of crude oils available to refineries, and changes in the mix of light products demanded—especially with diesel use growing faster than gasoline use in China and around the world.

GENERAL CONSEQUENCES FOR PRICES AND PRICE VOLATILITY In the near term, growing oil demand and the changing mix of products in China are likely to push up prices for crude oil (and price premiums for lighter oils) in the United States, boost prices for motor fuels, and increase the volatility of prices.

Crude Oil Prices and Costs of Refining Rising oil demand in China will increase the price of crude oil in the United States and around the world, which will be passed on to prices for all petroleum products—including gasoline and diesel fuel. Less clear is how the growing relative demand for motor fuels within China could further contribute to increased prices for those fuels in the United States. Projections from the Energy Information Administration made in 2005 indicate that Asia, with recent investment activity in China, is moving toward becoming the biggest center for petro leum refining in the world.46 All together, Asian countries already have about as much refinery capacity as North America or Europe (see Figure 4-1). As China becomes a growing presence in the worldwide refining industry, developments in its domestic petroleum markets will become increasingly important for costs of refining worldwide. 46

Department of Energy, Energy Information Administration, Annual Energy Outlook 2005 (February 2005), Figure 97.


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Figure 4.1

The growing relative preference of the Chinese market for light products such as diesel fuel, gasoline, and petrochemical feedstocks increases the price for premium grades of crude oil and adds to refiners’ costs for processing low-quality oils. The market for premium crude oils is seeing some of that effect on prices (see Figure 4-2). Light, sweet crude oils have high natural yields of light distillates and low levels of sulfur. China, like many other countries, is competing more and more with the United States in the world oil markets for the types of crude oil that are most easily refined into motor fuels, especially gasoline and diesel that will satisfy increasingly stringent environmental standards for sulfur emissions. To boost the percentage yield of light products, one alternative to processing additional volumes of light, sweet oils is to invest in additional refinery capacity to process more of the less-valuable heavy, sour oils. Among the key refinery investments needed are catalytic cracking, hydrocracking, and coking units for boosting the yield of gasoline and diesel components from heavier oils and

40


hydrotreating units for removing sulfur from sour oils (see Box 4-1). Current indications are that the Chinese are interested in making such investments. For example, the Chinese refining industry has recently partnered with ExxonMobil and the Saudi Aramco to build a new refinery that would be capable of handling the heavier grades of Saudi crude oil.47

Figure 4.2

At a basic level, the shift in worldwide demand to motor fuels means an increase in the necessary yield of those products from crude oil and, hence, an increase in the costs of producing motor fuels. However, the magnitude of that cost increase would depend on the location and design of new refining capacity. New capacity that yielded a mix of products that did not match relative demand would generally add further to refiners’ costs and possibly to transportation costs. (There is a lowest-cost configuration of refinery processes for producing any particular mix of finished products, and costs increase sharply with efforts to push the yield of particular products beyond the optimal yield for a given configuration.). 47

See “Exxon, Partners to Start Work on Oil Refinery Project in China,” Washington Post, July 1, 2005, p. A8.


41

In the current example, to meet the growing demand for motor fuels, that prospect of further cost increases would be true whether the incremental refinery yield of light products was too low (raising the need to import additional motor fuels as well as placing additional demand on refineries elsewhere) or too high.

Price Volatility A part of the current concern about the impact of China’s growing energy demand on oil price volatility relates to the fact that the available buffer of excess production capacity in the world market is already very slim (see Figure 4-3). Without that buffer—crude oil that is available on short notice at a relatively constant cost—any increase in demand must be met from costly incremental sources. The ability of crude oil producers worldwide to boost output in response to supply disruptions or demand surges is likely to remain limited or even diminish further for the next few years, until Saudi Arabia and perhaps a few

42


other countries meet their stated goals of attaining substantial levels of excess capacity.

Figure 4.3

The strategic inventories of crude oil held by the United States and several other countries may be able to augment that slim buffer of excess current production capacity. Efforts by China to develop its own strategic inventory may be important in that context, although that inventory will not be completed within the next five years (see Box 4-2). Currently, the United States and other members of the International Energy Agency are committed to maintaining a 90-day emergency supply of oil and oil products (or an equivalent capability to restrict consumption). However, it is difficult to know how well a release of those strategic inventories (or conservation measures) would help to moderate the price impact of a disruption, since the impact would depend on the timing and magnitude of such a response.48 China currently is not a member of IEA, and it is not known if or how it would coordinate its stock withdrawals with other countries’. Over the next 48

For a critique of the emergency response in the 1990 Gulf War, see Congressional Budget Office, Rethinking Emergency Energy Policy (December 1994).


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few years, as China works to fill its reserve, those additional oil purchases could make worldwide oil markets tighter than they already are.

THE IMPACT OF RISING TOTAL OIL DEMAND ON WORLDWIDE CRUDE OIL PRICES Depending on whether growth is slower or faster, CBO estimates that the increase in China’s total demand for petroleum in the next five years could cause oil prices to be as much as $7 to $14 a barrel higher (in 2005 dollars) than they would be otherwise. If those increases in crude oil costs were completely passed through to consumers, prices for a gallon of gasoline or diesel could rise by between 16 cents and 33 cents in the United States. The potential range of effects on oil prices is inferred from the increase in oil consumption through 2010 in the slower- and faster-demand-growth scenarios on the basis of an approximation of the five-year price elasticity of net worldwide supply. That elasticity is an estimate of the percentage change in worldwide oil prices that would be necessary to eliminate a given percentage imbalance in worldwide oil supply and demand over that period. Specifically, it represents the

44


ratio of the percentage net disruption—whether attributable to a change in demand or supply—to the percentage price change. To illustrate those effects, this analysis assumes that the five-year elasticity is 0.2, which means that a 1 percent supply shortfall would require a 5 percent price increase response to restore balance in the market.49 To apply the net supply elasticity to the estimation of price change requires having an estimate of the base price (from which the change takes place) and the percentage change in consumption. In this case, the base price is the 2005 price of crude oil, and the percentage change in consumption is the growth in Chinese demand (from the slower- and faster-demand-growth scenarios) divided by worldwide oil consumption in 2005. On the basis of partial data for the year, worldwide oil consumption in 2005 was about 83 million barrels a day and the average world-wide oil price in 2005 (measured as the spot price for West Texas Intermediate crude oil, as traded on the New York Mercantile Exchange) was about $57 a barrel. With a projected five-year increase in Chinese demand of 2 million barrels a day (in the scenario of slower demand growth), the oil price change necessary to keep the market in balance would be nearly $7 a barrel (or about 16 cents a gallon). With an increase in Chinese demand of 4 million barrels a day (in the scenario of faster demand growth), the oil price increase would be about $14 a barrel (or about 33 cents a gallon). The price effects from the two scenarios do not encompass the full range of possible outcomes. For example, the International Energy Agency projects that the increase in oil consumption in China by 2010 could be as low as 1.5 million barrels a day (see Table 3-2 on page 19), which would result in smaller price increases than what are shown here. Or, with a return to the demand increases 49

Both the Energy Information Administration and the International Monetary Fund assume the oneyear elasticity of net oil supply to be 0.1. (Mathematically, the net supply elasticity reflects the sum of the absolute values of the demand and the supply elasticities.) See Department of Energy, Energy Information Administration, “Rules-of-Thumb for Oil Supply Disruptions” (September 2, 2004), available at www.eia.doe.gov/emeu/security/rule.html; and International Monetary Fund, World Economic Outlook (April 2005), Table 4.7. That figure would be low for an analysis of five-year effects, since the response of petroleum production and consumption to changes in price generally increases over time as oil businesses have more time to find additional oil and consumers have more opportunities to make investments to save energy or switch to other forms of energy. From the models of the Energy Information Administration, the 10-year response of total oil demand to oil prices is about 0.2 (absolute value). With that demand reduction likely to be followed by a very small supply response, the five-year elasticity for net supply would normally be something more than 0.2. Given current market conditions, however, with members of the Organization of Petroleum Exporting Countries generally unable to rapidly increase production, it is likely that the market’s response to any given shortfall will have less additional supply to draw on than in past years. For those reasons, 0.2 is taken here to be representative of the likely five-year impact.


45

recorded in 2003 and 2004, growth in oil consumption could be above the level in the faster-demand-growth case, which would result in larger price increases. And in both scenarios, because of the current tight situa tion in worldwide oil markets, it is hard to know what level of price response would be necessary to keep the world oil market in balance. In particular, there is a new uncertainty underlying future oil supplies, as OPEC shows the first indications of having difficulty keeping pace with worldwide demand. In early 2005, Goldman Sachs suggests that oil prices could spike as high as $105 a barrel in 2007, and IMF described an alternative scenario wherein oil prices could reach $80 a barrel in 2006.50 If the worldwide oil supply remained relatively unresponsive to price changes, both the low- and high-end price impacts presented in this analysis could be greater than they would be otherwise. However, some analysts still hold with the view that worldwide supplies remain adequate and that oil prices will fall in the next few years, back below $35 a barrel. That view of falling prices in the face of rising demand suggests an expectation that a strong supply response to prices above $35 should be under way, in which case the price impact of higher demand for oil in China could be smaller than the estimates presented here. To further underscore the uncertainty about future supplies, with crude oil prices remaining above the $60 a barrel level (for West Texas Intermediate) in early 2006 and no immediate downturn in sight, some forecasters have begun to rethink that downward trajectory. For example, in its July 2005 International Energy Outlook, the Energy Information Administration had forecast that worldwide oil prices would reach only about $32.50 a barrel by 2010 (in 2005 dollars). But in January 2006, EIA released a revised outlook that has oil prices falling to only about $45 a barrel by 2010 (in 2005 dollars).51

THE IMPACT OF INCREASING DEMAND FOR LIGHT PRODUCTS ON THE COSTS OF REFINING PETROLEUM In addition to the cost of crude oil, the cost to refine petroleum is the other component of U.S. motor fuel prices that is likely to be affected by developments 50

The investor report by the Goldman Sachs Group is not publicly available; a summary appears in Peter A. McKay, “Goldman Analysts Deliver Oil Shock,” Wall Street Journal, April 1, 2005, p. C4. A scenario that has oil prices spiking to $80 a barrel is assessed in International Monetary Fund, World Economic Outlook, Figure 4.6. 51 Department of Energy, Energy Information Administration, Annual Energy Outlook 2006 (Early Release), January 2006. Forecasts are inflated to 2005 dollars using the implicit GDP price deflator.

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in China’s petroleum markets. As discussed here, the cost to refine petroleum is the average cost of converting crude oil into finished products and distributing those products to wholesale markets. Changes in those costs worldwide are in part a consequence of China’s growing total demand for petroleum because within that total demand, the demand for motor fuels (diesel and gasoline) and other light, costly-to-refine products is growing even faster. Yet those demand pressures would probably have only a small impact on costs of refining as long as China’s efforts to keep pace with its changing demand did not introduce significant distortions into the worldwide market for refined products.52 In the absence of such distortions, the impact on costs for gasoline and diesel in the United States would be nearly three cents a gallon in the slower-demand-growth scenario and about five cents a gallon in the faster-demand-growth case (both in 2005 dollars). A general rule of thumb for gauging how changes in the cost to refine oil relate to the changing product mix can be inferred from the historical relationship between gross refinery margins and light product yields, controlling for other important factors affecting costs (such as inventory change, which affects distribution costs, and environmental requirements) and profitability (such as capacity utilization and interest rates). To illustrate the relationship between costs of refining oil and product yields, the only controlling factor considered here is the change in refined product inventories (see Figure 4-4). (The logic is that when storage tanks are filling rapidly, the costs of delivering finished products will be higher than they otherwise will be; and when tanks are being drained, the delivery costs will be lower. Those cost changes are assumed to be passed through to prices.) The statistical relationship between margins, yields, and stock changes suggests that an overall increase in the yield of motor fuels of 1 percentage point (with no further change in stock additions) will be associated with an increase in average refining costs of $1.33 a barrel (or just over three cents a gallon), in 2005 dollars.

52

Distortions could be introduced in several ways—for example, if China opted for a policy of pursuing self-sufficiency in its capacity to refine crude oil or, at the opposite extreme, opted to rely completely on increased imports of products from refineries elsewhere. (The cost increases resulting from such distortions of free trade are not evaluated in this analysis.)


47

That rule of thumb reflects a number of simplifying assumptions.53 Its calculation of gross refinery margins (a weighted average of gasoline and diesel prices minus crude oil costs) omits other costs of refinery operations that may have been changing over the past decade. For example, some of the new costs for complying with environmental regulations are not included. Despite that limitation, research indicates that changes in the gross and net margins are closely related.54 Also, the data on annual stock changes omit information on inventories in China and other developing countries. Those inventory data are generally not available, and it is not known how their omission affects the results. In general, a preferable way to model the determinants of refiners’ costs—which is beyond the scope of this paper—would consider the increases in average costs of refining for the different basic configurations of refineries, from simple hydroskimmers to complex coking facilities (see Box 4-1). Those increasingly complex configurations add equipment to recover hydrogen, remove sulfur, and extract and recombine hydrocarbons to alter the mix of finished petroleum products. Both of CBO’s scenarios of future growth assume that most of the increase in Chinese petroleum demand through 2010 will be for light products. Adding the respective increases in light product demand—about 2 million barrels a day in the slower-growth scenario (4.5 percent a year) and 4 million barrels a day in the faster-growth scenario (7.5 percent a year)—to the level of worldwide oil consumption in 2004 and recalculating the worldwide yield of light products indicates how Chinese demand may affect those yields and, hence, costs of refining. In the slower-growth scenario, the worldwide yield of light products from crude oil in 2010 would increase from 67.5 percent to 68.3 percent, adding about $1 a barrel (or nearly three cents a gallon), in 2005 dollars, to the cost of supplying gasoline and diesel in the United States and other countries.55 In the faster-growth scenario, the worldwide yield in 2010 would increase from 67.5 53

In particular, those relatively small impacts assume that worldwide efforts to accommodate the changing demand mix reflect optimal levels of new investment around the world and trade in crude oil and finished products. That is, the world’s petroleum refiners (including refiners in China) would be free to respond to the growing and changing demand for petroleum products in China, so that the changes in refining capacity worldwide, combined with new patterns of trade, would help to supply finished products everywhere at the lowest cost. On that basis, the change in the average global refinery yields that was necessary to meet the new Chinese demand for light products would be most relevant for understanding the resulting change in refining costs in the United States. 54 For example, see Department of Energy, Energy Information Administration, Performance Profiles of Major Energy Producers 2003 (March 2005), Figure 47. 55 To illustrate, the calculation is 68.3 percent minus 67.5 percent (or 0.8 percent) times $1.33 a barrel, which equals $1.06 a barrel. With 42 gallons in a barrel, the impact of that slower-growth scenario is equivalent to about 2.5 cents a gallon.

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percent to 69.1 percent, adding just over $2 a barrel (or about five cents a gallon), in 2005 dollars.

Figure 4.4


49

Figure 4.5

Evidence of changing refinery yields in China is consistent with demand changes there. China’s increased production of light products in the past two years stands out compared with the increases for those products in the United States and the rest of the world (see Figure 4-5). But the recent sharp increase in product demand appears to have surprised Chinese refiners as much as it did energy analysts elsewhere. China’s oil industry has responded to that high demand growth by accelerating construction of new refineries (with government assistance in the form of expedited siting and construction permits). Refinery investment

50


took an especially large jump from January 2005 to January 2006 (see Figure 4-1 on page 28). Nine projects currently in progress or awaiting government approval would add about 2 million barrels a day of new distillation capacity before 2010 (see Table A-10).56 If all of those projects are completed as planned, China’s total capacity will be about 8 million barrels a day at that time—a level that would be insufficient to meet all the expected increase in oil use in CBO’s faster-growth scenario. If China is expecting faster demand growth, consistent with the government’s 10-year plan, it is unclear whether the current level of refinery investment reflects a strategy to rely increasingly on imported oil in the future or just a lag in making investments in refinery capacity sufficient to keep pace with demand. In March 2006, the government announced planning goals for refinery capacity in 2010 that would boost that capacity by more than 30 percent above current levels.57

OTHER INFLUENCES ON COSTS TO REFINE OIL The impact of increasing light product yields on costs of refining is more complicated than the simple relationship estimated in this paper. Some of the influences that may affect that relationship are transitory, successively pushing costs up and then back down, and others are more sustained in nature. An example of the type of event that can alter costs temporarily by raising demand or restricting refinery activity is the damage from Hurricanes Katrina and Rita in 2005. That damage significantly disrupted the supply of refined petroleum products in the United States, causing the margins of refiners in the Gulf Coast to more than quadruple from August to September.58 Among the factors that could influence worldwide costs of refining or refinery margins over a long period are changes in the volume of sales, which directly affect the profitability of supplying motor fuels and influence how much of any increase in costs of refining can be reflected in refinery margins and passed through to retail consumers. 56

Those projects are reviewed in Kang Wu and Fereidun Fesharaki, “As Oil Demand Surges, China Adds and Expands Refineries,” Oil & Gas Journal (July 25, 2005), pp. 20-24; and Department of Energy, Energy Information Administration, “China,” EIA Country Analysis Briefs (updated in August 2005), available at www.eia.doe.gov/emeu/cabs/china.html. 57 China Daily, “China To Boost Oil Refinery Capacity,” March 17, 2006, available at www.chinadaily.com.cn/english/doc/2006-03/17/content_544001.htm. 58

Current information on refinery margins in major refining centers is available in International Energy Agency, Oil Market Report, October 11, 2005.


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Other important factors that could add to costs and would need to be addressed in order to best establish the relationship between refinery yields and margins include:

• • • •

The changing quality of available crude oils, The increasing costs of complying with environmental rules, The increasing use of nonoil inputs (such as ethanol) to produce motor fuels, and The growing difficulty of siting new refineries (potentially a concern in China as well as in the United States).

For one additional factor—changes in the relative demand for gasoline and diesel fuel within the total mix of light products—the direction of impact on the costs of refining is less clear. Most of the growth in total petroleum sales worldwide and in sales of light products has been for diesel fuel. In the United States, diesel consumption tends to grow with increases in long-haul trucking and, hence, with overall economic output (which means at a faster pace), whereas gasoline consumption tends to grow with increases in population (which means at a slower pace).59 Those different causes probably exist in China, too, where the rate of growth in the use of diesel fuel is higher than that for gasoline. In China, truck traffic is growing with the economy, as is the number of small rural vehicles (already in the millions). Outside the transportation sector, growth in the demand for diesel for distributed electricity generation (by individual businesses and for buildings) has been high, too. It is not clear what the higher growth in the demand for diesel (relative to that for gasoline) may mean for costs of refining. In general, increased yields of gasoline are more costly to obtain than high yields of middle distillates (diesel fuel and heating oil). But in the past few years, wholesale prices for diesel have been approaching and, on occasion, exceeding the prices for gasoline. That may be a short-term phenomenon that will pass with some redesign of refineries. But with an increasing imbalance projected in the light product mix over the next five years, the rise in the cost of diesel relative to that of gasoline could persist.

59

For a recent analysis discussing the link between freight traffic and economic growth, see Congressional Budget Office, Freight Rail Transportation: Long-Term Issues (January 2006).

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IMPLICATIONS FOR POLICIES AFFECTING INVESTMENT IN U.S. REFINERIES China’s demand for petroleum in general—and for light products in particular—may add to cost pressures on U.S. refiners and could affect future refinery investment and operations. Even before the latest growth in Chinese demand, some analysts were claiming that refineries in the United States faced a number of policy-related constraints on their ability to meet growing demand at home and to comply with new environmental laws affecting product quality and plant emissions.60 In 2005, the hurricane damage to refineries along the U.S. Gulf Coast and the resulting large increase in refinery margins added to concerns about the adequacy of capacity. Those concerns have been accompanied by calls for specific policy changes to remove such constraints or to otherwise support increased investment in refineries. Changes in Chinese demand could put pressure on U.S. refiners in two ways. If China consumed an increased share of the light, sweet (or low-sulfur) crude oils to feed its demand for diesel, gasoline, and petrochemicals, then U.S. refiners would have to invest more than they otherwise would in the increased processing of heavy, sour oils. Alternatively, if China decided to rely increasingly on imports of refined petroleum products, that could put increased pressure on U.S. refiners to divert products from domestic markets to export markets—if not directly to China, then to other countries, who may in turn be the ultimate exporters to China. (Equivalently, U.S. refiners might have to boost output if U.S. importers of refined products saw their foreign sources of gasoline and die-sel—mainly in Europe and Latin America—diverted to China.) Aside from additional pecuniary costs for producing clean fuels, the additional refinery activity in the United States also could be related to additional social costs in the form of increased emissions from those plants. Advocates of a change in policies affecting refineries point to a number of constraints on refiners’ ability to process the heavier, more-sour oils and on their ability to expand output and capacity.61 Those constraints include ones that arise from emissions controls on refineries—a cones quence of national clean air laws (establishing ambient air quality standards and limiting plant emissions of sulfurous and nitrous compounds) and restrictions on technologies used at 60

For example, see National Petroleum Council, Observations on Petroleum Product Supply, A Supplement to the NPC Reports: U.S. Petroleum Product Supply and U.S. Petroleum Refining (December 2004). 61 Ibid.


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industrial fuel-burning installations (known as New Source Review). Other constraints on refinery operations arise from standards for the motor fuels themselves, including clean air laws that restrict the amount of certain toxic chemicals in gasoline and, more recently, new limits on the sulfur content of gasoline and diesel. Some analysts also believe that local requirements for permits may be impeding the construction of new refineries. But refiners in the United States have been able to meet growing demand for motor fuels by expanding the downstream capacity at existing refinery complexes.62 How much longer that type of expansion can continue is unclear, however. In the future, some all-new refinery complexes may well become the more economical investment—as may be evidenced by the increases in refinery margins that probably will follow the growing worldwide demand for oil products. At that time, local requirements for permits could become restrictive. The consequences of China’s economic growth for the costs to U.S. refiners from complying with existing and new policies affecting their capital spending and operations will depend on changes in the worldwide trade in refined products. Consideration of the full international picture is beyond the scope of this paper, although two basic effects are worth noting. If excess refinery capacity emerged in other countries (whether in countries with low economic growth or in oilexporting countries that decided to further develop their export capacity), the need for new capacity in the United States would be smaller than what it would be otherwise. Or, if fast-growing countries did not expand their refinery capacity, the call on U.S. refiners to boost their exports would be greater than what it would be otherwise. That future trade in petroleum products could also have consequences for the types of refinery investment that the United States might want to make. As this paper points out, the mix of products being consumed in Asia is changing, as China and other countries demand more gasoline, diesel, and other light products (especially petrochemical feedstocks). For example, if China did not alter the complexity of its refineries to boost the percentage yield of motor fuels, its efforts to produce additional motor fuels from refineries of a more-standard configuration would yield an excess supply of heavy, residual products. Those heavy products then could be exported to the United States or elsewhere, where significant capacity already exists to process them into more useful products. In that situation, the United States might want even more capabilities to convert those 62

For example, see D.J. Peterson and Sergej Mahnovski, New Forces at Work in Refining (Arlington, Va.: RAND Science and Technology, 2003).

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heavy products, although negative environmental consequences could ensue from processing feedstocks that could have an especially high content of sulfur and heavy metals.

APPENDIX A DETAILED TABLES This appendix presents 10 tables that convey additional background information on the Chinese economy and its energy sector.


55

56



57

58



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Chapter 2

U.S.-CHINA TRADE: USTR’S CHINA COMPLIANCE REPORTS AND PLANS COULD BE IMPROVED *

United States Government Accountability Office GAO HIGHLIGHTS Why GAO Did This Study Congress mandated that the United States Trade Representative (USTR) annually assess China’s trade compliance and report its findings to Congress. In addition, USTR conducted an interagency “top-to-bottom review” of U.S. trade policies toward China. USTR’s resulting February 2006 report outlined U.S objectives and action items. GAO was asked to (1) evaluate USTR’s annual China trade compliance reports to Congress and the degree to which they present information necessary to fully understand China’s compliance situation and (2) examine the status of the plans presented in USTR’s February 2006 top-to-bottom report. GAO systematically analyzed the contents of USTR’s compliance reports from 2002 to 2007 and reviewed information on the status of agencies’ monitoring and enforcement activities. *

This is an edited, reformatted and augmented version of United States Government Accountability Office publication GAO-08-405, dated April 2008.

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United States Government Accountability Office

What GAO Recommends To improve U.S. monitoring and enforcement related to China, USTR should (1) systematically identify and report the number, type, and disposition of issues in its annual compliance reports to Congress; (2) update and improve the plans in its 2006 top-to-bottom report; and (3) take steps to assess its implementation of these plans. USTR did not comment on GAO’s recommendations but expressed concern about quantifying compliance information and said the top-to-bottom report was a one-time policy document, not a plan. Still, GAO believes effective reporting enhances USTR’s ability to provide useful information on China’s WTO compliance and the status of U.S.-China trade objectives to Congress.

WHAT GAO FOUND United States Government Accountability OfficeUSTR’s annual reports to Congress, which detail U.S. industry concerns with China's compliance and progress on resolving such concerns, are very consistent in format and language. However, they lack any summary analysis about the number, scope, and disposition of reported issues that would facilitate understanding of developments in China’s trade compliance and better tracking of the effectiveness of U.S. monitoring and enforcement efforts with China. For example, USTR’s narrative reports make it difficult to understand the relative level of progress China made in each trade area in a given year. USTR reported issues that spanned nine trade areas and ranged from very specific issues to broader concerns; however, USTR’s narrative reports make it difficult to ascertain specific changes or trends. GAO’s systematic content analysis quantified the number, type, and disposition of trade issues and identified 180 individual compliance issues from 2002 to 2007. GAO analysis showed that China resolved a quarter of these issues, but made no progress on one-third of them. Also, GAO’s analysis revealed that China’s progress in resolving compliance issues varied by trade area and has been slowing over time, especially since 2004, when most progress was made. GAO could only partially determine the status of U.S. agencies’ implementation of USTR’s 2006 top-to-bottom report, which outlines broad objectives and priority goals for U.S.-China trade relations as well as specific action items. GAO found that key trade agencies made considerable progress implementing planned action items. They increased bilateral engagement with the Chinese and monitoring and enforcement capacity by increasing staffing levels and training opportunities, but staffing gaps and limited Chinese language

U.S. – China Trade

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capacity are challenges at some agencies. However, GAO could not determine agencies’ progress toward achieving some U.S. objectives and goals identified in the report. USTR does not formally assess its progress or measure program results. The lack of linkages between U.S. objectives and planned action items and undefined terms make it difficult to assess whether the steps agencies described taking were effective. Furthermore, the report has not been updated to reflect recent developments.

Source: GAO analysis of USTR data.

ABBREVIATIONS AD/CVD FAS HHS JCCT SED TPRG TPSC TRM TBT USDA USPTO USTR WTO

Antidumping/Countervailing Duty Operations Foreign Agricultural Service Department of Health and Human Services Joint Commission on Commerce and Trade Strategic Economic Dialogue Trade Policy Review Group Trade Policy Staff Committee Transitional Review Mechanism technical barriers to trade United States Department of Agriculture United States Patent and Trademark Office United States Trade Representative VAT value added tax World Trade Organization

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April 14, 2008 The Honorable Max Baucus Chairman Committee on Finance United States Senate Dear Mr. Chairman: Recognizing that monitoring and enforcing China’s trade commitments, as specified in China’s December 2001 World Trade Organization (WTO) accession agreement, might prove difficult, Congress mandated that the United States Trade Representative (USTR) review and assess China’s compliance and annually report these findings to Congress.1 According to these reports, China’s record in resolving compliance issues is mixed, although China has taken significant steps to implement its trade commitments and open its markets to foreign goods and services since its accession.2 Many of China’s WTO commitments were phased in over the first 5 years and have largely been implemented, but compliance with some has proven especially difficult. In addition to these annual compliance reviews, USTR conducted a onetime interagency “top-to-bottom review” of U.S. trade policies toward China. USTR’s review considered GAO’s prior work, which identified opportunities to improve U.S. government efforts in this area. USTR reported on the results of this review in February 2006 and concluded that the United States was entering a new more mature phase in its relationship with China that required it to readjust its trade resources and priorities to meet new challenges. In response to your request to understand the U.S. government’s progress in monitoring and enforcing China’s trade commitments, we reviewed (1) USTR’s series of annual reports titled Report to Congress on China’s WTO Compliance and (2) USTR’s February 2006 top-to-bottom report, U.S.-China Trade Relations: Entering a New Phase of Greater Accountability and Enforcement. We (1) evaluated the degree to which USTR’s annual reports to Congress on China’s 1

U.S.-China Relations Act of 2000 (Pub. L. No. 106-286, Div.B, Title IV, § 421(a), 114 Stat. 880a 903). 2 See USTR, 2002 Report to Congress on China’s WTO Compliance (Washington, D.C.: Dec. 11, 2002); USTR, 2003 Report to Congress on China’s WTO Compliance (Washington, D.C.: Dec. 11, 2003); USTR, 2004 Report to Congress on China’s WTO Compliance (Washington, D.C.: Dec. 11, 2004); USTR, 2005 Report to Congress on China’s WTO Compliance (Washington, D.C.: Dec. 11, 2005); USTR, 2006 Report to Congress on China’s WTO Compliance (Washington, D.C.: Dec. 11, 2006); and USTR, 2007 Report to Congress on China’s WTO Compliance (Washington, D.C.: Dec. 11, 2007).


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WTO compliance present information necessary to clearly understand China’s compliance situation and (2) examined the status of USTR efforts to implement the action items and achieve the objectives presented in its February 2006 top-tobottom report.3 We reviewed and systematically analyzed the detailed narrative descriptions of China’s compliance issues in USTR’s 2002 to 2007 reports to Congress, quantified the number of compliance issues reported in each year by USTR, and categorized the progress USTR reported in resolving particular compliance issues.4 Our analysis relied on USTR’s reports, and we did not do our own independent assessment of China’s compliance with its trade commitments or of the actions taken by USTR or other agencies. We interviewed key industry associations and verified with them that USTR’s annual reports are generally fair and complete representations of U.S. industry concerns.5 To assess USTR’s progress in implementing its top-to-bottom report, we reviewed the document to identify the objectives, related priority goals, action items, and implementing steps. We then had USTR and three key agencies (Departments of Commerce, State, and Agriculture) explain how they implemented the objectives, priority goals, action items, and implementing steps, and provide documentation to support their responses. To the extent possible, we independently verified their responses against information in agency reports, planning documents, WTO and Joint Commission on Commerce and Trade (JCCT) documents, and staffing data. In addition, to support our review, we interviewed officials at USTR, the Departments of Agriculture (USDA), Commerce, and State, and private sector groups in Washington, D.C., and in Beijing, China. We conducted this performance audit from March 2007 to April 2008 in accordance with generally accepted government auditing standards.

3

4

5

USTR, U.S.-China Trade Relations: Entering a New Phase of Greater Accountability and Enforcement, Top-to-Bottom Review (Washington, D.C.: Feb.

11, 2006). In a prior GAO report, GAO, U.S. China Trade: Opportunities to Improve U.S.

Government Efforts to Ensure China’s Compliance with World Trade Organization Commitments, GAO-05-53 (Washington, D.C.: Oct. 6, 2004), we examined the scope and disposition of USTR’s 2002 and 2003 Report to Congress on China’s WTO Compliance.

See appendix I, the objectives, scope, and methodology in GAO-05-53 for detailed explanation of how we systematically verified the content of USTR’s 2002 and 2003 reports.

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RESULTS IN BRIEF USTR’s annual reports to Congress do not have the systematic analysis needed to clearly understand China’s compliance situation. The reports, which describe many issues with China’s compliance and progress on resolving such issues in detail, are very consistent in format and language. However, they lack summary analysis about the number, scope, and disposition of reported issues, which would facilitate understanding of developments in China’s trade compliance and better tracking of the effectiveness of U.S. monitoring and enforcement efforts with China. For example, USTR’s narrative reports make it difficult to understand the comparative level of progress China made in each trade area in a given year and identify overall patterns or trends over time. Therefore, we conducted a systematic content analysis of USTR’s annual reports in order to quantify the number, type, and disposition of trade issues, and our analysis identified about 180 individual compliance issues from 2002 to 2007. These issues spanned nine trade areas and ranged from very specific issues, such as China failing to establish or designate an official journal dedicated to publication of all laws and regulations, to broader concerns such as a lack of transparency in its quota allocation process. Our analysis of USTR’s reports showed that China resolved a quarter of these issues, but made no progress on one-third of them. In addition, our analysis revealed that China’s progress in resolving compliance issues appears to be slowing over time, especially since 2003 and 2004, when most progress was made. We also found that China’s progress on resolving individual issues varies significantly by trade area. For instance, USTR reported that the highest proportion of issues on which China either made progress or resolved the issue were in the agriculture section, and the lowest proportion of progress was in import regulation. We were able to only partially determine the status of the U.S. agencies’ implementation of USTR’s 2006 top-to-bottom report, which outlines broad objectives, priority goals and action items for U.S.-China trade relations and serves as a plan to focus U.S. government resources. On one hand, we found that USTR and the other agencies have made considerable progress implementing the planned action items listed in the report. The key U.S. trade agencies took steps to increase bilateral engagement with the Chinese, expand the U.S. government’s capacity to enforce and negotiate by increasing staffing levels in headquarters and overseas, and improve training opportunities. However, we found that some previously identified management challenges, namely staffing gaps and limited Chinese language capacity, remain at some agencies. On the other hand, we could not fully determine USTR’s progress toward achieving the report’s broad


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objectives, which go beyond trade compliance. While this report lays out USTR’s plans for U.S.-China trade relations, USTR does not formally assess its progress or measure its results as we have recommended in our past reviews of other USTR plans. The lack of linkages between U.S. objectives and planned action items and undefined terms makes it difficult to assess whether the steps agencies reported taking were effective. Furthermore, the report has not been updated to reflect developments such as the creation of the Treasury-led Strategic Economic Dialogue (SED) and U.S. trade actions against China. To improve policymakers’ and the public’s understanding of China’s trade compliance situation, USTR should clearly and systematically identify the number, type, and disposition of the trade issues it is pursuing with China and report this and more detailed trend information in its annual China trade compliance reports to Congress. To help achieve U.S. trade objectives with China, USTR should update and improve the plans reported to Congress in its 2006 top-to-bottom report by considering the recent developments and the results of ongoing U.S. monitoring and enforcement activities and by reviewing how specific implementing steps and action items align with broad objectives and priority goals. USTR should also take steps to monitor implementation of these plans over time. In responding to our draft report, USTR officials said they appreciated our advice to ensure that USTR is doing the most effective job in reporting on results and they would consider our insights and ideas but did not comment specifically on our recommendations. They asked us to clarify certain aspects of our analysis of their annual reports and raised several concerns. For instance, USTR believed that we undervalued the systematic analysis in their annual reports, that there were inherent limitations and difficulties in developing meaningful quantitative measures, and was concerned about the advisability of providing quantitative analysis in USTR’s annual reports. However, we disagree and continue to believe that providing summary analysis -- both quantitative and qualitative -- in the annual reports would enhance understanding about China’s compliance situation and provide important information for Congress to conduct oversight and for senior policymakers to assess the success of USTR’s and other key trade agencies’ activities. USTR has many options for tailoring such analysis in order to address any concerns they might have. With regard to the top-to-bottom-review, USTR officials stated that it was a not a plan “in the narrow and specific sense” used in our analysis; instead it was a one-time policy document that was not intended to be updated. USTR stated it does provide updates through USTR’s annual reports to Congress on China’s WTO compliance. However, it is our understanding that USTR’s report on the

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results of the top-to-bottom review was a plan, based on interviews with USTR staff and our reading of the document. USTR’s report has many of the characteristics of a good plan and addresses our 2004 recommendation for a China unit plan in that the report establishes goals and priorities for the various China Affairs Office’s activities. While USTR provides numerous reports to Congress on its activities, USTR still has not updated the six objectives and 31 prioritygoals specified in the top-to-bottom report to reflect subsequent developments nor formally assessed progress. GAO advocates agency strategic planning and using such plans on an ongoing basis as a management tool. We suggest that USTR reconsider its treatment of this report as a one-time policy statement and that it update and improve the report in order to enhance accountability and inform all stakeholders, including Congress and the public. We also received technical comments from USTR and the Departments of Agriculture, Commerce, and the Treasury, and we have made changes throughout this report to update information and to clarify our findings as appropriate.

BACKGROUND China’s December 2001 accession to the WTO resulted in commitments to open and liberalize its economy and offer a more predictable environment for trade and foreign investment in accordance with WTO rules. The U.S. government’s efforts to ensure China’s compliance with its trade commitments under the WTO are part of an overall U.S. structure, led by USTR, to monitor and enforce foreign governments’ compliance with existing trade agreements.6 Among other things, USTR is required by law to identify any foreign policies and practices that constitute significant barriers to U.S. goods and services, including those that are covered by international agreements to which the United States is a party.7 At least 16 other agencies are involved, but USTR and the Departments of Commerce, State, and Agriculture have the primary responsibilities regarding trade agreement monitoring and enforcement. Each of these four key agencies has within its organizational structure a unit that focuses on China or the greater Asian region. 6

The WTO was established in 1995, and exists to facilitate the implementation, administration, and operation of multiple agreements that govern trade among its member governments to resolve complaints regarding another members’ noncompliance with WTO commitments. 7 See 19 U.S.C. § 2241(a)(1)(A)(i) and (a)(2)(c).


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These units have primary responsibilities for coordinating the agencies’ China-WTO compliance activities, although numerous other units within the agencies are also involved. The units routinely draw on assistance from experts in these other units to obtain information and expertise, as needed. Additionally, the key agencies have units in China or at the WTO, and staff in those overseas units are also involved in the agencies’ compliance activities.

USTR IS REQUIRED TO REPORT ANNUALLY TO CONGRESS ON CHINA’S COMPLIANCE WITH ITS TRADE COMMITMENTS USTR’s annual compliance reports examine nine broad categories of WTO commitments undertaken by China and include a detailed narrative outlining China’s compliance with these commitments. USTR is required to report annually to Congress on China’s compliance with commitments made in connection with its accession to the WTO, including both multilateral and bilateral commitments made to the United States.8 The reports, which are submitted to Congress every year by December 11, the anniversary of China’s accession to the WTO, are consistent in format and language. They are approximately 100 pages in length and divided into nine broad sections based on categories of WTO commitments. These sections are (1) trading rights and distribution services, (2) import regulation, (3) export regulation, (4) internal policies affecting trade, (5) investment, (6) agriculture, (7) intellectual property rights, (8) services, and (9) legal framework. In each of these sections, USTR identifies areas where progress has been achieved by China in meeting its trade commitments, and USTR also describes the shortcomings with a lengthy description of the specific, as well as broad compliance issues faced by U.S. industry. As USTR notes, the report does not provide an exhaustive analysis of China’s implementation of the particular commitments made in China’s WTO accession agreement. The report incorporates a broad range of input from key federal agencies and U.S. industry. USTR bases the reports on its own experiences as well as information it collects from federal agencies such as the Departments of Commerce, State, Agriculture, and the Treasury through both an interagency process, as well as by working with officers from these agencies at the U.S. embassy and consulates general in China. In addition, USTR seeks public participation by publishing a notice in the Federal Register, holding a public 8

Pursuant to section 421(a) Div.B. Title IV of Pub. L. No. 106-286.


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hearing, and incorporating written comments and testimony. Industry associations we interviewed confirmed that USTR fairly represents the concerns and interests of U.S. business in its annual narrative reports on China’s compliance.

USTR CONDUCTED AN INTERAGENCY TOP-TO-BOTTOM REVIEW OF U.S.-CHINA TRADE RELATIONS Since GAO last reported on China’s compliance with its trade commitments in 2004, USTR undertook an interagency top-to-bottom review of U.S.-China trade relations over the past 25 years and issued a report in February 2006.9 USTR’s report noted that earlier U.S. trade policy with China focused on bringing China into the international trading system and urging China to implement its new WTO commitments. Its report focused on (1) identifying core principles and key objectives of U.S. trade policy with China; (2) assessing the current status and establishing priority goals for each key objective; and (3) identifying the specific action items that will help the United States achieve its priority goals. The report stated that the United States has entered an important new phase of accountability and enforcement in its trade relationship with China and will expect China to play a greater role in strengthening the global trading system. USTR stated in the report that given the importance of U.S. trade with China and the challenges that continually confront the United States as it enters this new period, the United States should readjust its U.S. trade resources and priorities.

USTR’S ANNUAL REPORTS TO CONGRESS DO NOT SYSTEMATICALLY ANALYZE CHINA’S PROGRESS IN RESOLVING COMPLIANCE ISSUES USTR’s annual reports to Congress do not have the systematic analysis needed to clearly provide an understanding of China’s compliance situation. While the reports describe many issues with China’s compliance and progress on resolving such issues, they lack summary analysis about the number, scope, and disposition of reported problems that would facilitate understanding of key China trade issues and developments and allow the agency to track its effectiveness in monitoring and enforcing China’s trade compliance. Therefore, we conducted a 9

GAO-05-53.


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systematic content analysis of USTR’s reports in order to quantify the number, type, and disposition of trade issues. We identified 180 compliance issues from 2002 to 2007, spanning nine trade areas ranging from very specific issues to broader, more complex concerns. Our analysis further revealed that while China has resolved some issues, most issues have persisted without resolution. In addition, our analysis showed that China’s progress in resolving issues varies by trade area. More detailed information on China’s slowed progress in certain areas and faster progress in others might help Congress better understand China’s compliance. USTR also reported continuous engagement with China through multiple avenues in order to solve compliance issues but has not mentioned taking any action on one-quarter of outstanding compliance issues. Additionally, since USTR’s latest report, China made further progress on various compliance issues.

USTR’S ANNUAL REPORTS LACK SYSTEMATIC ANALYSIS AND COMPARATIVE INFORMATION While the lengthy detailed narrative in USTR’s reports describe many issues with China’s compliance, as well as China’s successes and progress on resolving such issues, more systematic analysis is needed to clearly understand the overall compliance situation. It is difficult to get a sense for the relative progress being made in each of the nine areas from reading the narrative descriptions. For instance, the reports do not describe how much progress is being made in the area of agriculture relative to the progress being made in intellectual property rights or services. In addition, USTR does not quantify the number of compliance issues or clearly describe the disposition of such issues. USTR also does not clearly identify priority areas or rank the issues in order of importance. While USTR highlights five or six areas of particular concern in the executive summary, some of these areas are crosscutting issues that involve more than one specific trade area. The reports also do not give a clear indication of the level of progress being made overall in each year, or show the relative progress made in one year versus other years. While USTR noted that the progress has slowed in recent years, there is no further information about the degree of this stagnation. Moreover, USTR’s narrative reports lack any high-level analysis, which might facilitate better monitoring and enforcement, and raise important questions that might prompt agencies to adjust their tactics and approaches. Therefore, more specific information on China’s slowed progress in certain areas and faster progress in

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others might help Congress better understand the trade compliance situation in China in a given year.

USTR REPORTS THAT CHINA MADE PROGRESS ON IMPLEMENTING ITS TRADE COMMITMENTS In its reports, USTR highlighted numerous areas in which China has successfully implemented its commitments since joining the WTO in December 2001. China’s WTO commitments are broad in scope and range from general pledges for how China will reform its trade regime to specific market access commitments for goods and services. In 2006, when deadlines for almost all of China’s commitments had passed, and China’s transition period as a new WTO member was essentially over, USTR reported that China had taken significant and impressive steps to reform its economy. In 2007, USTR also reported that China made noteworthy progress in adopting economic reforms that facilitated its transition toward a market economy. According to USTR, these actions include repealing, rewriting, or enacting more than 1,000 laws, regulations, and other measures, enacting annual reductions in tariff rates, eliminating nontariff barriers, expanding market access for foreign services providers, and improving transparency. Table 1 provides some examples of China’s successful implementation of its WTO commitments from each of USTR’s annual reports from 2002 through 2007.

USTR’S REPORTS CONTAIN A SIGNIFICANT NUMBER AND WIDE ARRAY OF REMAINING COMPLIANCE ISSUES Our analysis of USTR’s reports to Congress from 2002 to 2007 identified 180 compliance issues mentioned in the reports spanning all nine areas of China’s WTO commitments. The greatest number of compliance issues mentioned were in the areas of import regulation and services, and there were relatively few issues mentioned in legal framework and export regulation (see table 2). China’s WTO commitments are broad and complex. Some require a specific action from China, such as to reduce or eliminate certain tariffs. Others are less specific, such as those that require China to adhere to WTO principles of nondiscrimination treatment of foreign and domestic enterprises. Compliance issues also ranged in scope from specific, relatively straightforward issues, such as the late issuance of regulations,


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to broader and more crosscutting concerns, such as questionable judicial independence, which are more difficult to resolve and assess. The compliance issues can be the result of a range of factors, from political resistance, to lack of technical capacity, to issues of resources and coordination among Chinese ministries. Table 1: Examples of China’s Successful Implementation of Its WTO Commitments, 2002-2007

Source: GAO analysis of USTR’s 2002-2007 Reports to Congress on China’s WTO Compliance.

It is important to note that not all compliance issues mentioned in USTR’s reports equally affect U.S. exports to China and that some issues are more easily resolved than others. Thus, while USTR’s reports identify key areas of concern, the economic importance of many individual issues cannot be easily quantified. USTR does not assign economic value to these concerns in its reports, and we did not attempt to calculate the importance or otherwise prioritize or rank the issues in our analysis.

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Table 2: Number of Compliance Issues in Each Trade Area of China’s Trade Regime, 2002-2007


WHILE CHINA RESOLVED SOME ISSUES, MOST ISSUES HAVE PERSISTED WITHOUT RESOLUTION Our analysis revealed that over 60 percent of the compliance issues USTR reported to Congress were either resolved or progress was made on them from 2003 to 2007. A compliance issue is considered resolved if USTR reported that actions were taken by China that settled the specific issue mentioned. Our analysis shows that almost one-quarter of all compliance issues mentioned between 2002 and 2007 were ultimately resolved (see fig. 1). See table 3 for examples of compliance issues that have been resolved. In addition, none of the issues that were reportedly resolved resurfaced in later reports. Furthermore, according to our analysis, USTR indicated that China made progress, but did not resolve, about 40 percent of the compliance issues reported. An issue was considered to be one in which China made some progress if in any year USTR reported some type of improvement in the situation, or if action taken by the Chinese improved but did not completely resolve the issue. For example, if USTR reported that China announced a commitment to take a certain action, such as revise a law, which would eventually resolve the issue, then this was counted as progress made in the year in which this commitment was made. Progress can


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range in magnitude from small to substantial on a particular issue, as well as in frequency of occurrence, with some issues making progress in only 1 year and others in many years. For example, China made progress in improving its inconsistent application and duplication in certification requirements related to standards and technical regulations in only 1 of the 6 years the issue was reported. In contrast, USTR reported that China made progress toward improving transparency related to the administration of its tariff rate quota system for bulk agricultural commodities in 4 of the 6 years the issue was reported.

Source: GAO analysis of USTR data. Figure 1: Current Status of All Compliance Issues, 2002-2007

Table 3: Examples of Compliance Issues That USTR Reported Were Resolved, 2002-2007

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United States Government Accountability Office Table 3. Continued


Table 4: Examples of Compliance Issues Where USTR Reported That China Made No Progress, 2003-2007


Additionally, our analysis of USTR’s reports showed that 37 percent of all compliance issues mentioned from 2002 to 2007 achieved no resolution or any progress over the entire period. An issue was considered to have made no progress if the reports either explicitly noted that no progress had been made on that particular issue or if the reports did not indicate that China took any action to


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address the issue in the given year. See table 4 for examples of issues that made no progress over the period 2003 to 2007. In addition, our analysis showed that most compliance issues reported over this period have persisted for many years. For instance, over 30 percent of all issues were mentioned in USTR’s annual reports for at least 5 of the 6 years. In addition, less than 40 percent of all issues were present in USTR’s reports for 1 or 2 years; the remainder of issues, over 60 percent, was mentioned in the reports for at least 3 years or more (see fig. 2).

Source: GAO analysis of USTR data. Figure 2: Persistence of Compliance Issues and Number of Reported Compliance Issues, 2002-2007

In addition to the issues that were resolved over the period 2002 to 2007, we discovered that a number of the issues mentioned in the reports were not explicitly resolved but were nevertheless dropped from the report. An issue is considered dropped from the report if the issue was mentioned in 1 or more years of USTR’s report, and not mentioned in a later year, without any discussion about resolution of the issue. In total, 15 percent, or 27 issues, were not explicitly resolved according to USTR’s reports but were dropped from subsequent years, with the ultimate status of such issues remaining unknown. Some of these issues might remain outstanding but USTR chose not to include them in the report for a particular reason, or the issues no longer present concerns for U.S. industry and, therefore, were excluded from the report. A USTR official noted that issues

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disappear from the report for various reasons, such as the business community no longer considers it an issue, or the Chinese have offered a suitable explanation, ultimately settling the issue.

CHINA’S PROGRESS ON COMPLIANCE ISSUES SLOWED SINCE 2004 While 37 percent of all issues mentioned in USTR’s reports from 2002 to 2007 were either resolved or dropped, the number of issues mentioned in each annual report remained fairly stable over the period 2003 to 2007 (see fig. 2). This suggests that, as compliance issues were resolved or dropped from the report, a similar number of new compliance issues arose and were included. USTR reported 15 to 27 new issues in its report each year, with a decreasing number of new issues added over time from 2003 to 2007.

Source: GAO analysis of USTR data. Figure 3: China’s Progress on Compliance Issues Over Time, 2003-2007

While USTR noted generally that China’s progress in resolving compliance issues has slowed, our analysis provided information about the degree to which progress has slowed in recent years. In its 2007 annual report, USTR stated that beginning in 2006 and continuing throughout 2007, China’s progress toward


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further market liberalization began to slow. Consistent with USTR’s characterization, our analysis showed that while there have been variations over time, the number and proportion of issues being resolved or making progress has slowed, from just under 50 percent of issues in 2003 down to about 30 percent of issues in 2007. For instance, the number of issues resolved in each year has declined since 2004. In addition, the number and proportion of issues that achieved some progress in each year peaked in 2003, declining steadily through 2006, and improved in 2007 (see fig. 3). In addition to China’s slowed progress over the period, our analysis found that there are an increasing number and proportion of compliance issues where USTR reported no progress, which suggests that issues persist for several years without resolution as new compliance issues continue to arise. According to our analysis, the proportion of issues making no progress rose from just over 50 percent in 2003 to about 70 percent in 2007, with a peak number of issues making no progress in 2006. USTR explained in its 2007 report that U.S. industry is less focused on China’s willingness to implement the specific commitments of its entry agreement than on Chinese policies and practices that undermine previously implemented commitments. According to the testimony submitted to USTR by one major trade association, the current concerns lie with more complicated issues such as a deviation from the WTO’s national treatment principle, inadequate protection of intellectual property rights, nontransparent legal and regulatory processes, and the development of technical and product standards that may favor local companies. Thus, while USTR reported that China has implemented many of its WTO commitments, many of the outstanding and new issues are broader, more complex issues that undermine the commitments and reforms already implemented.

PROGRESS VARIES BY TRADE AREA IN USTR’S ANNUAL COMPLIANCE REPORTS USTR noted that China’s record on implementing its WTO commitments is decidedly mixed, without presenting detailed summary information. Through our analysis, we also found that the reported progress varies significantly by trade area (see fig. 4). China has made more progress in some commitment areas—such as trading rights and distribution services, agriculture, and internal policies—having resolved over 30 percent of all issues mentioned in each area, and less progress in other areas such as services and intellectual

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property rights, where less than 10 percent of issues have been resolved. Overall, while most trade areas have a significant proportion of outstanding issues, the proportion of issues where China is making progress or reaching resolution varies. For instance, in the area of agriculture, the total number of compliance issues mentioned each year is declining slightly, with a large number of issues, about 85 percent, having either reached resolution or achieved some progress from 2003 to 2007. Also, similar to the overall compliance situation, the number of issues making progress or being resolved in the area of agriculture seems to be declining. In fact, USTR mentioned some specific sticking points such as transparency and selective intervention in the market by China’s regulatory authorities. USTR explained that, while U.S. exports of many agriculture commodities to China have reached record levels, the increases are largely due to the result of greater demand.

Source: GAO analysis of USTR data. Figure 4: Number of Issues and Overall Disposition, by Trade Area

Thus, while the results in the agricultural sector seem positive, there are still some important compliance issues that remain outstanding. Conversely, other trade areas such as intellectual property rights have seen less progress, with the smallest proportion of issues, less than 10 percent, reaching resolution and a sizable proportion of issues, over 30 percent, not making any progress from 2003 to 2007. In addition, there are an increasing number of


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compliance issues mentioned in this area, with a peak in 2006. USTR noted in its 2007 annual report that while China has put in place a relatively good set of laws and regulations aimed at protecting intellectual property rights, some critical measures still need to be revised, and China’s overall enforcement of these laws has been ineffective. Thus, while many of the intellectual property laws have been rewritten, there are still many outstanding issues, and more complex issues related to enforcement continue to arise.

ANNUAL REPORTS DESCRIBE THE TYPES OF U.S. ACTIONS TO RESOLVE COMPLIANCE ISSUES USTR engages with China through multiple avenues to solve compliance issues but has not mentioned taking action on several outstanding compliance issues. In its annual reports, USTR outlines various types of actions taken in order to resolve the compliance issues mentioned in the reports. These actions include raising the issue at multiple forums and dialogues with the Chinese, including the U.S.-China JCCT, the Strategic Economic Dialogue (SED), the Transitional Review Mechanism (TRM) or other forums at the WTO, or raising the issue bilaterally with the Chinese through another mechanism. For this analysis, we considered USTR to have taken action on a particular issue if USTR mentioned some type of activity in any of its annual reports, such as the ones listed above. USTR reported taking at least some type of action on most compliance issues mentioned but did not mention taking any type of action on one-quarter of compliance issues mentioned (see fig. 5). Specifically, USTR raised 32 percent of issues at the JCCT, 54 percent of issues at the TRM or other WTO forum, 13 percent of issues at the SED, and 57 percent of issues were pursued bilaterally with the Chinese through some other mechanism. Most of the issues where USTR did not report taking any type of action were in the areas of agriculture, import regulation, intellectual property rights, and internal policies affecting trade. USTR officials also highlighted that among the actions they reported, they have taken the added step of filing WTO cases against China after bilateral negotiations have made no progress. They noted that the United States has brought six such WTO cases against China (see table 5).


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Source: GAO analysis of USTR data. Figure 5: USTR Action on Individual Compliance Issues

Table 5: List of WTO Cases Filed by the United States Against China

Source: WTO.


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CHINA MADE FURTHER PROGRESS ON VARIOUS COMPLIANCE ISSUES IN DECEMBER 2007 Since USTR’s latest report, gains were made at the December 2007 JCCT and SED meeting that are not mentioned in the 2007 annual report on China’s compliance with the WTO. In December 2007, the United States and China participated in the third cabinet-level meeting of the SED and the 18th JCCT meeting; USTR, the Departments of Commerce and the Treasury have all cited numerous areas of progress resulting from those meetings. However, due to the timing of the meetings in late in 2007, the results were not included in USTR’s 2007 annual report and, therefore, were also not included in our analysis of such reports. Specifically, the Department of Commerce cited several areas of progress as a result of the December JCCT meeting, including steps taken by China in the areas of intellectual property, product safety, and market access in several industries such as medical devices, agriculture, and telecommunications. Table 6: Examples of Key Areas of Progress from December 2007 JCCT and SED Meetings

Sources: GAO analysis of information from the Departments of Commerce and the Treasury.

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In addition, the Department of the Treasury also noted many areas of progress resulting from the December SED meeting including areas such as integrity of trade and product safety, financial sector reform, environmental sustainability, and transparency (see table 6).

USTR’S PROGRESS TOWARD ACHIEVING TOP-TO-BOTTOM REPORT OBJECTIVES CANNOT BE FULLY DETERMINED We were only able to partially determine the status of USTR’s 2006 top-tobottom report, which outlines objectives for U.S.-China trade relations and serves as a plan to focus U.S. trade resources and priorities in this regard. On one hand, we found that USTR and the other agencies have made considerable progress implementing planned action items listed in the report. The key U.S. trade agencies took steps to increase bilateral engagement with the Chinese and expand the U.S. government’s capacity to enforce and negotiate by increasing staff levels in headquarters and overseas and improving training opportunities. However, we found that some previously identified management challenges—staffing gaps and limited Chinese language capacity—remain. On the other hand, we could not determine progress toward achieving the top-to-bottom report’s broad objectives, which go beyond trade compliance. While this report lays out USTR’s plans for U.S.-China trade relations, USTR does not formally assess its progress or measure its results as we have recommended in our past reviews of USTR plans. The lack of clear linkages between U.S. objectives and planned action items and vague language make it difficult to determine whether the steps agencies reported taking were effective. Furthermore, the report has not been updated to reflect subsequent developments.

TRADE AGENCIES HAVE MADE CONSIDERABLE PROGRESS IN IMPLEMENTING TOP-TO BOTTOM ACTION ITEMS We found that USTR and the key trade agencies have made considerable progress in implementing the planned action items listed in the top-to-bottom report. We learned that various agencies share responsibility for carrying out the activities planned in this report either individually or collectively. USTR informed us that, of the 25 implementing steps, 10 implementing steps were interagency;


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USTR was responsible for 6, the Department of Commerce for 5, other agencies for 3, and the Department of State for 1. After assessing the information provided by USTR and the other key trade agencies, we determined that 17 out of 25 steps were implemented or are in the process of being implemented; the status of 8 steps was unclear because the ‘top-to-bottom’ review did not define terms such as ‘strengthen’ and ‘effectiveness’ nor did it provide baseline data from which to measure progress. For example, with regard to strengthening interagency coordination, the report says that export promotion activities will be increased, but without any baseline measurement information we could not determine if there had been an increase in these activities. (See app. II, table 10, which identifies the 10 action items and the accompanying 25 implementing steps, along with agency responsibilities and status.) We confirmed that key U.S. trade agencies took steps to increase bilateral engagement with the Chinese and expanded the U.S. government’s capacity to enforce and negotiate by increasing staff levels in headquarters and overseas and by improving training opportunities. While assessing these agencies’ implementation of the top-to-bottom report action items, we also followed up on progress made addressing management challenges identified in our 2004 report on U.S. monitoring and enforcement activities related to China. We recommended that the key agencies take various steps to improve performance management pertinent to China WTO compliance efforts and that they undertake actions to mitigate the effects of staff turnover in the agencies China WTO compliance units. We found that some previously identified challenges—staffing gaps and limited Chinese language capacity—remained at some agencies.

U.S. GOVERNMENT INCREASED BILATERAL ENGAGEMENT WITH CHINA ON VARIOUS TRADE ISSUES As a result of the top-to-bottom report, key trade agencies are undertaking several action items to improve and increase bilateral engagement with China. The U.S. government has utilized two formal consultative mechanisms to address commerce, trade, and financial issues, both of which demonstrated an emphasis on high-level, bilateral engagement. First, the United States uses the JCCT, a forum for dialogue on bilateral trade issues and a mechanism to promote commercial relations. This forum had been elevated to a higher level after a 2003 meeting and refocused to give greater attention to outstanding trade disputes.

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Second, the United States and China created the SED in September 2006, as another bilateral high-level forum to address the most important, long- term, strategic issues in the United States-China economic relationship. The meeting of the SED, which is convened every six months, is led by a U.S. Cabinet Official and a Chinese Vice Premier, and each dialogue session comprises U.S. cabinet officials and Chinese ministers. The SED allows both governments to communicate at the highest levels and with one voice on issues of long-term and strategic importance, including issues that extend across multiple departments and agencies. The United States has three core objectives for the SED: (1) to advance the U.S.-China economic relationship by establishing new habits of cooperation; (2) to accelerate China’s next wave of economic transition; and (3) to encourage China to act as a responsible global economic power. According to Department of the Treasury officials, there are no formal working groups associated with the SED. Rather, U.S. cabinet officials and Chinese ministers determine strategic areas of focus for the intervening six months between meetings of the SED. For example, at the first SED in December 2006, civil aviation was selected. At second SED, product safety was identified and in December 2007 at the third SED, energy and environment was a strategic area of focus. Table 7: Examples of JCCT Working Groups

Source: Department of Commerce.


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According to some U.S. agency officials, there was confusion over the purpose of the SED when, at the May 2007 SED meeting, the United States used the meeting to discuss trade compliance issues. Officials told us that they have since clarified the issue. Department of the Treasury officials told us the JCCT focuses mostly on short-term trade issues, while the SED focuses on solutions to long-term, strategic, economic issues (see table 7 for list of JCCT work areas). USTR planned to strengthen and expand bilateral dialogues on numerous current and potential problem areas, another key action item in the top-to-bottom report. The U.S. government held a number of bilateral dialogues covering 8 different subject areas to address trade issues with China, which demonstrated a continuing emphasis on bilateral engagement (see app. II; table 10, which lists these dialogues). Many U.S. government agencies engaged their Chinese counterparts on a multitude of topics such as agricultural, environmental, labor, subsidies and standards, and telecommunications issues. While some of these dialogues are very active and have resulted in accomplishments such as China’s acceding and ratifying the World Intellectual Property Organization Internet Treaties in 2007, others dialogues have not yet been implemented. For instance, both the Environmental Protection Agency and the Department of Labor indicate they have not established formal dialogues with their Chinese counterparts as planned. There are other means of bilateral engagement. For example, USDA officials told us they prefer to handle issues with their Chinese counterparts using sciencebased rationale. This often requires USDA Foreign Agricultural Service (FAS) to engage Chinese officials in technical forums and through capacity building initiatives, even though USDA participates in high-level JCCT working groups on agricultural and sanitary and phytosanitary issues. The number of high-level meetings between senior U.S. and Chinese officials has increased. For instance, the key economic and trade agencies sent more cabinet and sub cabinet delegations to China to engage their Chinese counterparts on trade issues; senior-level delegations to China from various U.S. government agencies increased from 31 in 2006 to 63 in 2007, a level equal to about one a week.10 Furthermore, this represents a substantial increase from 2002 and 2003, where there were 13 and 23 such meetings, respectively.

10

These numbers are based on GAO analysis of unverified Department of State information. These numbers do not include congressional delegations.

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U.S. GOVERNMENT EXPANDED CAPACITY TO ENFORCE CHINA’S TRADE COMPLIANCE AND IMPROVED TRAINING, BUT STAFFING ISSUES PERSIST Since the top-to-bottom report, the key trade agencies have increased staff in headquarters and overseas to expand the U.S. government’s capacity to enforce China’s trade compliance and to negotiate with China on trade issues. They also increased staff training opportunities. GAO’s prior work recommended that the key trade agencies better manage their human capital to enhance the U.S. government’s China WTO compliance efforts and mitigate the effects of staff turnover. Nevertheless, agency officials told us they still experienced staffing gaps and turnover in key overseas offices and shortfalls in language skills.

Staff Levels Increased Key trade agencies have continued to increase staff positions to meet the demands of the U.S.-China trade relationship (see table 8). Staff resources more than doubled at headquarters and in Beijing since 2004. The estimated number of full-time equivalent staff in units most directly involved with China trade compliance efforts increased from 60 in fiscal year 2003 to 135 in fiscal year 2007. USTR doubled its staff positions in headquarters from 5 to 10 positions and established an internal China Enforcement Task Force that includes staff from USTR’s Office of General Counsel and the China Affairs Office to prepare and handle potential WTO cases. USTR also added personnel in its China office to coordinate collection and integration of information on current and potential China trade issues. In response to increased responsibilities arising from the new U.S.-China trade relationship, USTR, Treasury, and Commerce’s U.S. Patent and Trademark Office added four new positions at the embassy in Beijing. Department of Commerce’s and USDA’s Foreign Services in China are the largest overseas office for each department. For example, 10 percent of Commerce’s Foreign Commercial Service is in China. In addition, as a result of an increased focus on China, the FAS has increased the number of staff that work in China, which now accounts for 10 percent of its overseas staff, according to USDA.11 11

This is the percentage of FAS personnel stationed in China compared with all FAS personnel stationed overseas, not including contractors detailed to the United States Agency for International Development or locally employed staff working in FAS offices.


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Table 8: Comparison of Agency Staffing for Key China-Trade Units for Fiscal Years 2003 and 2007 at Headquarters and Overseas

Sources: GAO summary of USTR, Commerce, State, and USDA data. Note: Figures do not total precisely due to rounding and are authorized full-time equivalent slots. Overseas data includes U.S. government full-time equivalent slots only; it does not include staff outside of Beijing or Foreign Service Nationals. a The increased number of Import Administration staff working on China was due to the International Trade Administration Reorganization in 2004, which established the China/Non-Market Economy Unit within Import Administration Antidumping/Countervailing Duty Operations(AD/CVD). The China/NME Unit works almost exclusively on China cases. The offices included are AD/CVD Operations Offices 4, 8, and 9 and the Unit’s Senior Enforcement Coordinator’s Office. The current staffing number for the China/Non-Market Economy Unit is 55. This figure does not include the number of employees in Import Administration’s Office of Policy, who work substantially on China issues. b In fiscal year 2007, State estimated that it had another 20 staff that devoted part of their time to China WTO issues. c USDA’s FAS division estimates of full-time equivalent staff working on China compliance issues. Figures do not include other USDA agencies’ staff (e.g., the Animal and Plant Health Inspection Service or Food Safety and Inspection Service) that have routine responsibilities in supporting the government’s work on China-WTO compliance efforts or staff positions inside FAS that are obligated but unfilled.

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Staffing Gaps and Turnover Remain Furthermore, agencies have experienced staffing gaps and shortages. In headquarters, USTR experienced staff turnover from fiscal year 2006 to 2007. USTR’s China Affairs Office had four staff depart and hired five additional staff. As of November 2007, the office is authorized to have nine staff but only have eight. The International Trade Administration officials in the Department of Commerce said that there is still a relatively high amount of staff turnover because employees in the Market Access and Compliance acquire a skill set that is highly desirable and attractive to the private sector. Department of Commerce officials noted that one official in the Market Access and Compliance’s Office of Chinese Economic Area had moved from headquarters to Beijing since January 2007. Overseas, both the Departments of State and Commerce have experienced staffing challenges. For instance, a senior Department of State official told us there has been a high level of turnover in the economic section at the embassy, which has included curtailed Foreign Service rotations. These changes have resulted in significant gaps in filling positions and reorganizations to compensate for lost expertise. To maintain current staffing levels, the department has sometimes pulled staff from Chinese language training. Although State added seven positions in China as part of its Global Repositioning Initiative, only five were at the embassy in Beijing, and two staff still had not arrived at post as of the end of 2007.12 One of the five economic section positions at the Beijing embassy tasked to work on China trade compliance at the embassy has been seconded to work with the senior Department of the Treasury official at post. Similarly, the Department of Commerce’s Trade Facilitation Office has been understaffed and has experienced high turnover in two staff positions according to department officials. One Market Access and Compliance position was vacant for a year, and the office had waited over 6 months for a Director. We were told that the individual has been hired and assumed duty in late February 2008. A senior Department of Commerce official stated that one contributing factor to the high turnover for the Trade Facilitation Office is that department hires experienced people with China business backgrounds, in a highly competitive job market. These individuals are on a limited 2-year noncareer appointment (with the possibility of the appointment being extended to a maximum of 5 years) with no opportunities for promotion. 12

In 2006, the Department of State established the Global Repositioning Initiative to shift hundreds of positions from across the world to critical emerging areas in Africa, South Asia, and elsewhere that will shape U.S. interests in the future.


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Training Opportunities Expanded In 2004, GAO reported that the four key trade agencies lacked specific training relevant to executing China-WTO compliance responsibilities, but since then the Departments of Commerce and State, and USDA have offered staff opportunities for training on trade monitoring and compliance. Training opportunities for staff have increased, but most training is still ad hoc and does not apply specifically to China trade compliance. Department of State staff overseas stated they had sufficient funds for training. In addition, both departments offer courses online for staff. Department of State offers about nine training courses related to WTO compliance issues to its employees, as well as employees from other agencies. In fiscal year 2007, approximately 172 individuals took these courses. Since 2005, Department of Commerce has offered several training courses related to compliance and market access. Commerce employees in International Trade Administration participated in training on compliance and market access database. In addition, to ensure data accuracy in the Department of Commerce’s case database, about 195 employees have been trained on case procedures and received guidance on how to document their work in the database. USDA officials stated the agency increased training opportunities for its China staff since 2005.

Language Skill Gaps Remain Senior management from the Departments of Commerce and State expressed concerns about the language skills of China unit staff. For instance, newer staff often have insufficient language skills, according to a senior Commerce official. As of September 2007, the Department of Commerce’s Office of Chinese Economic Area offers Mandarin language training and has five staff taking the course; however, Beijing staff confirmed that they were not fluent in Chinese and said they rely on the Chinese Foreign Service Nationals to translate and conduct research to enhance the officers’ abilities to perform their duties. Some Department of State staff told us that officers come to the embassy before they have finished their language training. According to a senior Department of State official, this limits them in their official capacities. Although senior department management and staff said they had funds to take language training, the heavy

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visitor schedule and workload have made it difficult to consistently take advantage of the language instruction available at the post.13

PROGRESS TOWARD BROAD U.S.-CHINA TRADE OBJECTIVES IS DIFFICULT TO DETERMINE We could not determine agencies’ progress toward achieving the plan’s broader U.S.-China trade objectives for several reasons. First, USTR officials said that while the top-to-bottom report is their planning tool, they have not formally assessed the progress they have made in implementing it, although USTR officials told GAO that USTR periodically reviewed their progress and made informal internal assessments. However, USTR did not provide GAO any of its informal internal assessments. Second, assessing USTR’s progress toward achieving its objectives and priority goals for U.S.-China trade is difficult since the objectives and priority goals are clearly linked to the action items in the report. Furthermore, some of the action items use undefined terms such as “strengthen” and “effectiveness” and others do not include baseline information from which to measure progress. As a result, it is difficult to ascertain how the agency’s action items and implementing steps contribute to achieving the larger U.S. trade objectives and priority goals with China. Third, USTR has not updated the report despite major changes in the U.S.-China trade relations since conducting the topto-bottom review, such as the establishment of the Department of the Treasury-led SED in September 2006 and filing of several dispute settlement cases.

USTR USES THE TOP-TO-BOTTOM REPORT AS A PLANNING TOOL BUT DOES NOT FORMALLY ASSESS ITS PROGRESS IN IMPLEMENTING IT USTR officials told us they use the top-to-bottom report as the planning tool for USTR’s China Affairs Office, and it guides USTR’s as well as the U.S. government’s engagement with China on trade issues. Nevertheless, USTR officials told us they do not formally assess the progress they have made in implementing it. Rather, they said that in their regular discussions on China, they 13

GAO has reported on language skills shortfalls, including Chinese. See GAO, State Department: Staffing and Foreign Language Shortfalls Persist Despite Initiatives to Address Gaps, GAO-071154T (Washington, D.C.: Aug. 1, 2007).


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are inevitably touching on the issues in the top-to-bottom report. In Washington, D.C., and overseas, managers and staff we interviewed at other agencies said they were aware of the report, but that it was not used as a guide for planning their China trade compliance priorities. The top-to-bottom report indicated that the Trade Policy Review Group (TPRG) and Trade Policy Staff Committee (TPSC) were to conduct monthly reviews of the progress made in achieving the key objectives identified in the report to help ensure coordination of China trade policy formulation and implementation and appropriate focus among agencies on key U.S. trade objectives with China.14 However, USTR said that although these groups discuss key objectives and priority goals, they do not track progress made on achieving the action items. The TPSC Subcommittee on China met 5 times in 2007 between January and August to discuss various issues such as WTO disputes, SED and JCCT dialogues, and coordination with U.S. trading partners. The TPRG met 10 times between March 2006 and June 2007 to discuss a variety of issues related to its strategy in WTO dispute settlement. In addition, no minutes are kept on either the TPRG or the TPSC so we could not determine to what extent these objectives were informally discussed in these meetings.

Results Not Measured Furthermore, as discussed in the previous section of our report, USTR still does not attempt to measure the results of its efforts to resolve trade compliance problems with China, even though they are an integral part of many U.S.-China trade objectives. USTR’s top-to-bottom review drew upon GAO past reviews of monitoring and enforcement efforts. In GAO’s 2004 report, for example, we found that the specific units within the agencies most directly involved with China compliance activities lacked specific strategies for ensuring that they supported their agency’s goals, and they also did not assess their unit’s results. We noted that planning and measuring results were important components to ensuring that government resources were used effectively to achieve the agencies’ goals. In addition, we stated that good planning and management links overall agency goals

14

USTR administers and chairs both the Trade Policy Review Group (TPRG) and the Trade Policy Staff Committee (TPSC), which is composed of 19 federal agencies and offices; make up the sub-cabinet level mechanism for developing and coordinating U.S. Government positions on international trade and trade-related investment issues.

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to individual unit activities and priorities.15 We recommended that these agencies take steps to improve performance management pertinent to the agencies’ ChinaWTO compliance efforts. Specifically, we said that USTR should set annual measurable targets related to its China compliance performance measures and asses the results in its annual performance plan.

Other Key Agencies Have Some Related Plans We asked the other agencies to provide us with their China unit plans. However, the Department of State provided their information too late for us to assess. The Department of Commerce’s International Trade Administration has developed a strategic plan, and it has China objectives and goals that are broad; however, there is no performance measures related to China and the information provided on China is not very specific. The International Trade Administration’s Office of China Economic Area which has major responsibility for China compliance and trade issues does not have a specific unit plan, although Department of Commerce officials told us that the activities undertaken by the Office of the Chinese Economic Area are fully consistent with the International Trade Administration’s Office’s strategic plan. The Market Access and Compliance unit which is over the Office of China Economic Area does have a draft plan but it does not mention China specifically. USDA’s Office of Country and Regional Areas and the Office on Negotiations and Agreements have developed unit plans for China, but the documents have not been officially approved by agency management.

15

For examples of how to improve planning and to better measure results, see GAO, ResultsOriented Government: Practices That Can Help Enhance and Sustain Collaboration among Federal Agencies, GAO-06-15 (Washington, D.C.: Oct. 21, 2005); GAO, Results-Oriented Government: Improvements to DHS’s Planning Process Would Enhance Usefulness and Accountability, GAO05-300 (Washington, D.C.: Mar. 31, 2005); GAO, Results-Oriented Government: GPRA Has Established a Solid Foundation for Achieving Greater Results, GAO-04-38 (Washington, D.C.: Mar. 10, 2004), and GAO, Results-Oriented Government: Using GPRA to Address 21st Century Challenges, GAO-03-1166T (Washington, D.C.: Sept. 18, 2003).


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LACK OF LINKAGES AND SPECIFICITY MAKE IT DIFFICULT TO ASSESS PROGRESS Assessing USTR’s progress toward achieving its objectives for U.S.-China trade is difficult since the broad objectives and the more specific action items are not clearly linked in the top-to-bottom report. The top-to-bottom report sets forth the following six U.S.-China trade objectives:

• • •

• • •

Participation—integrate China more fully as a responsible stakeholder into the global rules-based system of international trade and secure its support for efforts to further open world markets; Implementation and compliance—monitor China’s adherence to international and bilateral trade obligations and secure full implementation and compliance; Enforcement of U.S. trade laws—ensure that U.S. trade remedies and other import laws are enforced fully and transparently, so that Chinese imports are fairly traded, and U.S. and Chinese products are able to compete in the U.S. market on a level playing field; Further market access and reform—secure further access to the Chinese market and greater economic reforms in China to ensure that U.S. companies and workers can compete on a level playing field; Export promotion—pursue effective U.S. export promotion efforts with special attention to areas of particular U.S. export growth potential in China; and Proactive identification and resolution of trade problems—identify midand long-term challenges that the trade relationship may encounter, and seek proactively to address those challenges.

However, these six objectives and 31 related priority goals are not linked to the 10 action items and 25 specific implementing steps. (See table 11 in app. II for a list of the six objectives and 31 related priority goals.) As a result, it is difficult to ascertain how the agency’s action items and implementing steps contribute to progress and achieve the larger U.S. trade objectives with China. Therefore, we asked USTR to identify which objective each action item and implementing step is supposed to help achieve. There was a wide range in the level of planned activity to achieve different objectives. Based on the information USTR provided, we found that 11 implementing steps focused on one

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objective concerning implementation and compliance, while other objectives concerning proactive identification and resolution of trade issues and export promotion each only had 1 implementing step associated with them. Furthermore, the scope and specificity of some objectives and their related priority goals, did not match the actions meant to implement them. Therefore, it is not clear that the planned priority goal actions, if implemented, would fully address all of USTR’s objectives. For example, as part of planned export promotion efforts, they intended to give special attention to noncoastal parts of China, from small/medium enterprises, from high-tech firms, and in sectors where the United States is competitive; in contrast, the planned action related to export promotion is very general in nature, is discussed in the context of strengthening interagency coordination, and does not mention any of these specifics. It was also difficult to assess progress because terms in the plan do not provide a means to understand how USTR or other government agencies might determine when an action item had been achieved. Several action items state that particular initiatives will be expanded, strengthened, or increased; however, no strategy or baseline information is provided to allow one to determine how this would be done or whether actions on the part of agencies have actually expanded, increased, or strengthened the program. For example, one action item is to “increase effectiveness of high-level meetings with China’s leaders,” but the implementing steps do not state how greater effectiveness will be accomplished; instead, the step is limited to “continue to hold high-level meetings.” Similarly, with regard to strengthening interagency coordination, the report says that export promotion activities will be increased, but without any details or measurement information we could not determine if there had been an increase in activity or how this might lead to strengthened coordination.

Plans Have Not Been Updated Finally, it is difficult to assess the status of U.S.-China trade objectives because the report does not reflect some important developments. USTR has not updated its plans. USTR stated in its report that these are “initial steps” and that additional action items would be developed and implemented in consultation with Congress and other stakeholders to ensure meaningful progress in achieving the


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reports’ key objectives.16 However, the action items in the report have not been updated since its issuance over 2 years ago in February 2006. There have been several important developments in U.S.-China trade since the top-to-bottom review occurred, which are not reflected in USTR’s report. The creation of the SED is a new high-level forum and now involves the Department of the Treasury. The United States has filed five dispute settlement cases at the WTO against China since February 2006 (see table 5). Also, U.S. industries have filed numerous trade remedy petitions against Chinese imports under U.S. trade laws, including requests for safeguard actions and antidumping and countervailing duty investigations. In 2007, Commerce made the determination to apply the countervailing duty law to Chinese imports, representing a major change from its long-standing policy of not applying this law to non-market economies.

CONCLUSIONS Clearer information on the number and disposition of trade issues with China and the trends over time helps Congress and the public understand the results of U.S. government monitoring and enforcement activities. It also better informs policymakers trying to adjust tactics in response to new developments and shift resources to where they can be the most effective. Measuring program results on an ongoing basis can be a powerful management tool. For example, analyses like the ones we conducted could prompt policymakers to shift priorities to focus on trade areas with the greatest number or most persistent unresolved issues. Also, it is possible that lessons can be learned from the tactics and approaches used in those areas where the most issues have been resolved. Similarly, USTR’s top-to-bottom review produced a 2006 governmentwide plan for U.S.-China trade relations. Since then, the key trade agencies have taken steps to implement the various action items this plan laid out, including an expansion of U.S. monitoring and enforcement capacity, increased number of bilateral forums for U.S.-China dialogue about trade and economic issues, and proactively identifying and resolving trade issues with China. However, it is not always clear how these activities will achieve the many objectives the United States has regarding trade relations with China. A clearer linkage between planned activities and objectives, and regular progress reviews could help agencies adjust 16

USTR told us they held 39 briefings or meetings with members of Congress in the past 2 years since the top-to-bottom report was written but were not able to identify the degree to which they specifically discussed progress toward achieving their objectives.

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priorities, focus their efforts, and ensure that there is movement toward all objectives. Furthermore, this plan for engaging China would be strengthened if it reflected new developments, like the creation of the SED, and the results from ongoing U.S. government monitoring and enforcement activities described in USTR’s annual trade compliance report to Congress. The upcoming change in administration, new Congress, expected changes in Chinese leadership, and 2-year anniversary of the top-to-bottom report, provide USTR with an opportune time to update its plan.

Recommendations for Executive Action To improve policymakers’ and the public’s understanding of China’s trade compliance situation, we recommend the USTR clearly and systematically identify the number, type, and disposition of the trade issues it is pursuing with China and report this and more useful trend information in its annual China trade compliance report to Congress. To help achieve U.S. trade objectives with China, we recommend USTR update and improve the plans reported to Congress in its 2006 top-to-bottom report by considering recent developments and the results of ongoing U.S. monitoring and enforcement activities and by reviewing how specific implementing steps and action items align with broad objectives and priority goals. We also recommend USTR take steps to formally monitor implementation of these plans over time.

APPENDIX I: OBJECTIVES, SCOPE, AND METHODOLOGY To assist Congress in better understanding the United States Trade Representative’s (USTR) reporting on the U.S. government’s progress in monitoring and enforcing China’s trade commitments, we reviewed two key USTR reports, its annual December 11 report to Congress on China’s WTO Compliance and its February 2006 top-to-bottom report, U.S.-China Trade Relations: Entering a New Phase of Greater Accountability and Enforcement. We were asked to (1) evaluate the degree to which USTR’s annual reports to Congress on China’s World Trade Organization (WTO) compliance present information necessary to clearly understand China’s compliance situation and (2)


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examine the status of USTR efforts to implement the action items and achieve the objectives presented in its February 2006 top-to-bottom report.17 To examine the scope and disposition of compliance issues, we reviewed USTR’s Report to Congress on China’s WTO Compliance from 2002 to 2007.18 These annual reports, mandated by Congress in conjunction with China’s 2001 accession to the WTO, incorporate a broad range of input from key federal agencies, as well as the business community. To assure ourselves that the reports generally included the main compliance issues and concerns that had arisen, we interviewed three key industry associations, which together represent over 1,300 companies in over 40 industries, in Beijing, China, and Washington, D.C., about USTR’s annual reports, and these groups noted that they were generally satisfied with the report’s portrayal of the compliance situation in China.19 We identified each unique compliance issue that was reported by USTR in the narrative of each of their annual reports. Our identification was based on USTR’s description and definition of problems in the narrative of the report. USTR’s categorization of issues in the report and the manner in which issues were grouped and presented, also guided the identification of individual issues. We did not include areas where China initially complied fully with its commitments and, therefore, no issues were raised, these were considered successes as reported in table 2. In all, we identified 180 issues in the six annual reports. To analyze the disposition of the compliance issues, we reviewed the narrative descriptions provided in the reports and made determinations according to three broad categories: No Progress Noted, Some Progress Noted, and Resolved. We categorized an issue as “No Progress Noted” if the report text either explicitly stated that no progress had been made or did not indicate that China had undertaken any actions to address the issue. We categorized an issue as “Some Progress Noted” if the report text indicated that China had undertaken any action to address the issue but had not completely resolved it. We categorized issues as “Resolved” if the report language clearly indicated that the compliance issue was resolved and the U.S. government was no longer pursuing a resolution of that 17 18

19

USTR, U.S.-China Trade Relations: Entering a New Phase of Greater Accountability and Enforcement, Top-to-Bottom Review (Washington, D.C.: Feb. 11, 2006). In a prior GAO report in October 2004 (GAO-05-53), we examined the scope and methodology and disposition of USTR’s 2002 and 2003 Report to Congress on China’s WTO Compliance. We relied on this prior analysis of the 2002 and 2003 reports and continued using the same methodology to analyze the 2004 through 2007 annual reports. In the prior GAO report (GAO-05-53), we also systematically cross-checked the reports with testimony and reports submitted to the Trade Policy Staff Committee, Subcommittee on ChinaWTO Compliance, as part of its 2002 and 2003 hearings on China-WTO compliance and other relevant reports. This analysis also found the USTR reports to be a generally fair and complete representation of U.S. industry concerns.

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particular issue (see table 9 for additional details). Two of our staff independently identified each compliance issue and made initial determinations of the dispositions. After those staff had reconciled differences in their initial identification and disposition of issues, additional staff reviewed issues and dispositions to ensure consistency and accuracy in the dispositions. We did not attempt to identify the relative importance of the compliance issues as the report text does not provide clear indications that would allow us to make that determination. However, we based our analysis on the premise that all these compliance issues had been considered serious enough by USTR to include in its annual reports. Indeed, USTR reported that it focused the report on trade concerns raised by U.S. stakeholders that merit attention within the WTO context. In some instances, we noted that after a compliance issue in a particular area had been resolved, other issues arose in the same area. For example, in some areas, after a particular commitment was implemented, other restrictions were imposed that made it difficult for U.S. companies to realize the full benefits of the commitment. In those instances, we identified two separate issues and noted their dispositions according to the evidence. As a result, our total count of issues includes several that are related, but that were identified as separate problems in USTR’s reports. Table 9: Description of GAO Categories for Disposition of China’s WTO Compliance Issues and Examples of Disposition


In addition, for the 2004 through 2007 annual reports, we quantified the number of issues where USTR mentioned taking various types of actions in order to resolve the issue in the narrative of the report. These actions include raising the


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issue at multiple forums and dialogues with the Chinese, including the JCCT, the Strategic Economic Dialogue (SED), the Transitional Review Mechanism (TRM), or other forums at the WTO, or raising the issue bilaterally with the Chinese through another mechanism. For example, regarding the concerns from the U.S. telecommunications industry about interference from Chinese regulators regarding standards and contract negotiations, USTR reported that they raised this issue during a 2004 JCCT meeting. Therefore, we noted that USTR took action toward resolving this issue at the JCCT. To assess USTR’s progress in implementing the objectives and action items presented in its February 2006 top-to-bottom report, U.S.-China Trade Relations: Entering a New Phase of Greater Accountability and Enforcement, we analyzed the document by identifying the six objectives and each of the associated priority goals. After that, we delineated the 10 action items and each of their associated implementing steps. We created a chart and divided the implementing steps under each associated action item. Next, we asked USTR to (1) identify the agency responsible for implementing each action item, (2) complete the chart, (3) indicate whether the action item was implemented and if so how was it implemented, and (4) provide supporting documentation for each response. Since we had observed that the action items were not clearly linked to the report’s objectives, we asked USTR to identify which objective the action item addressed. We also asked the Departments of Commerce and Agriculture to complete a chart for their individual agencies; identify which action item they were responsible for implementing, indicate the status of this action item, and provide supporting documentation for their responses. We asked the Department of State to provide documentation for the one step that USTR said this department was solely responsible for implementing. We conducted this performance audit from March 2007 to April 2008, in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives.

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APPENDIX II: STATUS OF TOP-TO-BOTTOM REVIEW Table 10 identifies the 11 action items and the accompanying 25 implementing steps, along with agency responsibilities and status in the top-tobottom review. Table 10: Action Items, Implementing Steps, Responsibilities, and Status


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Sources: GAO analysis of USTR, Departments of Commerce and State, and USDA information.

Table 11 is a list of the six objectives and 31 related priority goals in the topto-bottom review.

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United States Government Accountability Office Table 11: Top-to-Bottom Objectives and Priority Goals

Source: GAO analysis of USTR’s top-to-bottom report.


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APPENDIX III: COMMENTS FROM THE UNITED STATES TRADE REPRESENTATIVE Note: GAO comments supplementing those in the report text appear at the end of this appendix.

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GAO COMMENTS The following are GAO’s comments on the United States Trade Representative’s letter dated March 26, 2008.

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1. We disagree that report undervalues the systematic analysis of China’s WTO compliance contained in USTR’s annual reports. In our report, we acknowledge the detailed narrative information presented by USTR and the consistent format used to present this information in its annual reports on China’s WTO compliance. Nevertheless, we believe that the lack of systematic analysis in these reports make it difficult for Congress and the public to understand the overall compliance situation in China. USTR’s annual reports lack not only quantitative measurement and analysis, but qualitative summary analysis as well. While there is a significant amount of detailed information contained in USTR’s reports, it is difficult to determine the overall progress being made in each of the nine areas. In addition, without systematic analysis of the lengthy narrative descriptions it is difficult to assess the level of progress being made in each year, or the trends over time. While there are other ways to conduct such analysis, our work demonstrates that it is possible to provide both systematic qualitative and quantitative analysis to make the information in the report more meaningful and accessible. 2. We disagree with USTR’s statement that the variety and nuances of individual compliance issues make summary analysis meaningless. In fact, we believe the opposite is true. As we noted in our report, we identified each unique compliance issue based on the description and definition of problems in the narrative of the report. The categorization of issues in USTR’s reports and the manner in which issues were grouped and presented guided our identification of individual issues. We recognize that it is possible to group the issues differently, and if USTR finds another method of grouping and identifying issues, we encourage USTR to use such methods in providing summary analysis in future reports. In addition, we believe that this type of analysis is important to help Congress and the public better understand the overall compliance situation regarding China. Should USTR choose to define issues differently, we are confident that this will not change the overall results and patterns found through our analysis. Our report discusses the fact that the compliance issues mentioned in USTR’s reports may not all equally affect U.S. exports to China. In addition, we acknowledge that the level of progress made on one particular compliance issue might not be equal to the progress made on other issues. We agree with USTR that the relative importance of such issues and the relative progress made should guide decisions about how and when to devote resources to pursue particular compliance issues. That is precisely why we believe that more systematic information included in USTR’s annual compliance reports


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will provide further understanding to Congress and other stakeholders (and therefore help improve decision making regarding China’s trade compliance). To the extent that USTR believes it is important to give more weight to certain issues or explain other nuances that surround individual issues and the progress made on such issues, we encourage USTR to incorporate these variables when conducting any summary analysis for future reports. 3. We disagree with USTR that it will be ill-advised to provide a detailed quantitative analysis in USTR’s annual reports. We believe that more transparency and clarity in USTR’s reports enhances understanding about China’s compliance situation and provides important information for Congress to conduct oversight and for senior policymakers to assess the success of their activities. Such information would promote a more informed discussion about U.S.-trade policy toward China among all stakeholders. While USTR could decide to more clearly prioritize the almost 180 issues it reports, we did not advocate ranking these issues. In addition, U.S. trade negotiators could use summary information on China’s progress (or lack thereof) on resolving compliance issues to better argue that more needs to be done in certain areas and that the United States expects greater progress overall. Nevertheless, USTR would have many options for how to conduct and present such summary information, giving it the flexibility to mitigate any concerns that negotiators might have. 4. USTR states our categorization of compliance issues according to “action taken” and “no action taken” is unclear. Our report states clearly that our analysis of actions taken is based solely on the information provided in USTR’s annual reports. In addition, USTR stated that it was unclear how we categorized issues when they had brought a WTO case after bilateral negotiations. We considered any actions mentioned in USTR’s annual compliance reports at any WTO forum as “raised at the WTO” including dispute settlement cases. Furthermore, we added information to our report to clearly identify the cases filed by the United States against China. 5. USTR states the “top-to-bottom” report is not a “plan” in the narrow and specific sense used in our report. However, this was not our understanding based on interviews with USTR staff during our review and our reading of the document. USTR’s report on the results of its “top-to-bottom” report addresses our 2004 recommendation for a China unit plan in that the report establishes goals and priorities for the various China Affairs Office activities. GAO advocates agency strategic planning and using such plans on an ongoing basis as a management tool. USTR’s report has many of the characteristics of a good plan: it clearly defines objectives, goals, and action

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items; provides a detailed discussion of the problems; delineates agency responsibilities; provides specific activities and programs; and identifies human resources needed to achieve action items. In a February 2006 news conference announcing the report on the top-to-bottom report, the then U.S. Trade Representative was asked, among other things, how he would measure USTR’s progress on U.S.-China trade issues. He replied that “… the way to measure our performance is to go point by point through the report looking at the issues that I’ve talked about at the outset….” We believe that USTR should reconsider its treatment of this report only as a one-time policy statement. 6. USTR states that the top-to-bottom” report did not promise or anticipate the drafting of update. Based on our analysis of the report, it is implied that updates were going to be provided; however, we agree that the report includes no requirement or explicit promise to present revised objectives and goals, subsequent action items, and the degree of progress in a new version of the report. So we removed language indicating that there was an explicit requirement or promise. However, we suggest that USTR reconsider its treatment of this report as a onetime policy statement. Regular briefings are important, but USTR should have a written record that specifies revised objectives and goals, subsequent action items, and the degree of progress toward achieving them. USTR states that through annual reports like its annual reports to Congress on China’s WTO compliance, USTR already provides the written updates on the “top-to-bottom” report. While USTR provides numerous reports to Congress on its activities, USTR still has not updated the six objectives and 31 priority goals specified in the top-to-bottom report to reflect subsequent developments nor formally assessed progress. We still advocate that USTR update and improve this report, commensurate with its promised actions to help ensure that it is best positioned to meet its key China trade objectives and to ensure meaningful progress toward achieving them. USTR states that we misunderstood the relationship between action items, on the one hand, and objectives and priority goals, on the other. We found the relationship between action items and the objectives in the topto-bottom report were unclear. Therefore, we went through an exercise with USTR staff to identify how and whether short-term action items link to specific long-term objectives and priority goals and report on the outcome. In the future, USTR should formally identify these linkages in an updated plan that includes subsequent action items to ensure they are taking all the steps necessary to achieve their stated objectives.


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Our recommendations would enhance USTR’s accountability and inform all stakeholders, including Congress and the public, about the status of the U.S. objectives and priority goals for trade relations with China.

GAO’S MISSION The Government Accountability Office, the audit, evaluation, and investigative arm of Congress, exists to support Congress in meeting its constitutional responsibilities and to help improve the performance and accountability of the federal government for the American people. GAO examines the use of public funds; evaluates federal programs and policies; and provides analyses, recommendations, and other assistance to help Congress make informed oversight, policy, and funding decisions. GAO’s commitment to good government is reflected in its core values of accountability, integrity, and reliability.

Chapter 3

CHINA’S TRADE WITH THE UNITED STATES * AND THE WORLD Congressional Research Service SUMMARY As imports from the People’s Republic of China (PRC) have surged in recent years, posing a threat to some U.S. industries and manufacturing employment, Congress has begun to focus on not only access to the Chinese market and intellectual property rights (IPO) protection, but also the mounting U.S. trade deficit with China as well as allegations that China is selling its products on the international market at below cost (dumping), engaging in “currency manipulation,” and exploiting its workers for economic gain. Members of the 109th Congress introduced several bills that would impose trade sanctions on China for intervening in the currency market or for engaging in other acts of unfair trade, while the Bush Administration has imposed anti-dumping duties and safeguards against some PRC products and pressured China to further revalue its currency and remove non-tariff trade barriers. China runs a trade surplus with the world’s three major economic centers — the United States, the European Union, and Japan. Since 2000, the United States has incurred its largest bilateral trade deficit with China ($201 billion in 2005, a

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25% rise over 2004). In 2003, China replaced Mexico as the second largest source of imports for the United States. China’s share of U.S. imports was 14.6% in 2005, although this proportion still falls short of Japan’s 18% of the early 1990s. The United States is China’s largest overseas market and second largest source of foreign direct investment on a cumulative basis. U.S. exports to China have been growing rapidly as well, although from a low base. In 2004, China replaced Germany and the United Kingdom to become the fourth largest market for U.S. goods and remains the fastest growing major U.S. export market. China is purchasing heavily from its Asian trading partners — particularly precision machinery, electronic components, and raw materials for manufacturing. China is running trade deficits with Taiwan and South Korea and has become a major buyer of goods from Japan and Southeast Asia. In the past decade, the most dramatic increases in U.S. imports from China have been not in labor-intensive sectors but in some advanced technology sectors, such as office and data processing machines, telecommunications and sound equipment, and electrical machinery and appliances. China’s exports to the United States are taking market share from other Pacific Rim countries, particularly the East Asian newly industrialized countries (NICS), which have moved most of their low-end production facilities to China. This report provides a quantitative framework for policy considerations dealing with U.S. trade with China. It provides basic data and analysis of China’s international trade with the United States and other countries. Since Chinese data differ considerably from those of its trading partners (because of how entrepot trade through Hong Kong is counted), data from both PRC sources and those of its trading partners are presented. Charts showing import trends by sector for the United States highlight China’s growing market shares in many industries and also show import shares for Japan, Canada, Mexico, the European Union, and the Association for Southeast Asian Nations (ASEAN). This report will be updated bi-annually. U.S. trade with the People’s Republic of China (PRC) has raised several policy concerns. The trade is highly unbalanced in China’s favor with a U.S. deficit of $201 billion in 2005. Year-to-date (January-October 2006), the U.S. deficit reached $190 billion. Many associate this deficit with the concomitant loss of American jobs in industries competing with rapidly rising imports from China. Some policymakers as well as leaders of industry and labor blame China for unfair trade practices, including deliberately undervaluing its currency, which *

This is an edited, reformatted and augmented version of Congressional Research Service publication RL31403, updated January 24, 2007.

China’s Trade with the United States and the World

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they claim create an uneven playing field for U.S. companies when competing against imports from the PRC. U.S.-China trade issues are often driven by larger policy objectives. U.S. trade with China is but one aspect of the overall U.S. policy of engagement with the PRC, a policy that serves broader U.S. interests. Trade also underpins Beijing’s development strategy and contributes to domestic support for the PRC government. This report presents data and analysis of China’s trade that shed light on various policy issues, provides an overview of recent U.S. legislative initiatives, and examines the goals and constraints of U.S. trade policy toward the PRC. Some of the specific questions addressed are how the U.S. trade balance with China compares with those of the European Union and Japan, whether imports from China are merely replacing imports from other Pacific Rim nations, and how imports from China by industry compare with imports from other countries.

THE RATIONALE FOR U.S. POLICY AND INITIATIVES Allowing trade with China to develop is part of the overall U.S. strategy of engagement with the PRC. The rationale behind engagement is that working with China through economic, diplomatic, informational, and military interchanges helps the United States to achieve important national security goals such as preventing nuclear proliferation, defeating global terrorism, defusing regional conflicts, fostering global economic growth, and championing aspirations for human dignity.1 These goals are aimed at achieving U.S. national interests of security and prosperity for all Americans and projecting U.S. values abroad. U.S. trade policy toward China is based upon the assumption that trade between the two countries has both economic and political benefits: (1) in general, trade with China benefits both sides and allows for a more efficient allocation of available resources; (2) the rapidly developing Chinese economy affords a rare opportunity for U.S. businesses to become part of a huge and rapidly expanding market; (3) China’s membership in the World Trade Organization (WTO) compels the PRC to comply with international trading rules and spurs the development of market forces in the country; and (4) foreign trade and investment create a dependency on exports, imports, and foreign investment and other interaction with the outside world in China, which in turn strengthen its relations with the Western world, create centers of power outside the Chinese 1 The White House, The National Security Strategy of the United States of America (March 2006), available at [http://www.whitehouse.gov/nsc/nss/ 2006].

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Communist Party, and foster economic and social pressures for democracy; (5) a country as significant as China — accounting for a quarter of the world’s population, armed with nuclear weapons, and a member of the U.N. Security Council — cannot be ignored or isolated. According to some experts, globalization and economic interests may be exerting a moderating influence on Beijing’s policies toward protecting China’s national security interests. However, the Chinese Communist Party’s determination to maintain political legitimacy through economic growth also creates tensions with other countries and with emerging non-Party political actors. The possible problems or challenges raised by the U.S. strategy of economic engagement with China include adjusting to economic competition in sectors where China has a comparative advantage, responding to PRC unfair trade practices, and the rise of an economically powerful China that is becoming more assertive in global affairs: (1) Imports from China may be entering in such increased quantities that they are a substantial cause of serious injury, or threat thereof, to competing U.S. industries;2 (2) Imports from China may be dumped, subsidized, or unfairly aided by government entities in China, which still wield considerable influence in the economy;3 (3) According to some economists and many policymakers, the U.S. trade deficit with the PRC stems in large part from Beijing’s policy of maintaining an undervalued currency; (4) China has a poor record of adopting or enforcing internationally recognized standards for working conditions and environmental regulation which, in addition to violating human rights and harming the environment, may provide PRC businesses with unfair competitive advantages; and (5) U.S. economic engagement with China arguably contributes to the legitimacy of the socialist government and the strengthening of China’s military by facilitating general economic development. U.S. trade law and WTO regulations can deal with injury from imports and unfair trade practices. Trade disputes with China would normally be first discussed bilaterally before taking the case to the WTO for dispute resolution. China’s alleged violations of international labor and environmental standards, as well as its own laws and government regulations, have fewer institutional remedies for the United States. Policy options include working to improve China’s compliance through bilateral consultations and technical assistance, 2

See Sections 201 to 204 of the Trade Act of 1974 (19 U.S.C. §§ 2251-2254). 3 Unfair competition includes dumping (sales in the United States of an imported product at less than fair value), countervailable subsidies (excessive government subsidies of exporting industries) (see Subtitles A and B of Title VII of the Tariff Act of 1930, as added by the Trade Agreements Act of 1979 (19 U.S.C. §§ 1673 et seq.), and imports that infringe on intellectual property rights (see Section 337 of the Tariff Act of 1930, 19 U.S.C. § 1337).


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international organizations (such as the International Labor Organization), nongovernmental organizations, and multilateral treaties (such as the U.N. Framework Convention on Climate Change and Kyoto Protocol),4 and the threat of trade sanctions.

TRADE POLICY DEVELOPMENTS In the past few years, the United States has taken numerous actions in response to PRC trade practices that is has deemed unfair while China taken some incremental steps to heed U.S. demands.5 •

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In December 2006, China hosted the first China-U.S. Strategic Economic Dialogue led by U.S. Treasury Secretary Henry Paulson and PRC VicePremier Wu Yi. Talks focused on the following issues: China’s exchange rate flexibility, the bilateral trade imbalance, PRC intellectual property rights violations, energy, and the environment. The U.S. Treasury Department released a report on December 19, 2006, that did not refer to China as engaging in currency manipulation for the purpose of gaining a trade advantage. On January 13, 2006, the Bush Administration announced that it would apply the so-called military catch-all rule to items on the Commodity Control List which could require licenses for the export of items to China that could be used to strengthen China’s military power. On November 8, 2005, the United States Trade Representative (USTR) announced that the United States and China had, after three months of intense negotiations, reached a broad agreement on textile trade. The Agreement lasts through the life of the China WTO Textile Safeguard (through 2008), covers more than 30 individual products, and contains quotas that begin at low levels.6

4 See CRS Report RL33602, Global Climate Change: Major Scientific and Policy Issues, by John R. Justus and Susan R. Fletcher. 5 For further discussion of U.S. trade, U.S. -China trade, and U.S. trade policies toward China, see CRS Report RL33577, U.S. International Trade: Trends and Forecasts, by Dick Nanto; CRS Report RL33536, China-U.S. Trade Issues, by Wayne M. Morrison; and CRS Report RL32165, China’s Currency: Economic Issues and Options for U.S. Trade Policy, by Wayne Morrison and Marc Labonte. 6 Office of the United States Trade Representative. “USTR Portman Announces US-China Broad Textile Agreement.” USTR Press Release, November 8, 2005.


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On July 21, 2005, the PRC government announced that its currency, the yuan, would be revalued upward (from 8.3 yuan to 8.11 yuan to the U.S. dollar) and that its future value would be “referenced” to a basket of currencies. However, according to most experts, China’s central bank continues to intervene in the currency market in order to maintain a stable exchange rate.7 In May 2005, the Bush Administration imposed “safeguard” quotas on 16 categories of Chinese apparel in response to a surge in such imports following the lifting of textiles and apparel quotas worldwide in January 2005. In December 2004, the U.S. government imposed anti-dumping duties on imported Chinese bedroom furniture. This case, the largest anti-dumping action against China, reportedly has both supporters and opponents in the U.S. furniture industry.8 In September 2004, the U.S. government rejected a Section 301 (Trade Act of 1974) complaint filed by the China Currency Coalition alleging that China’s fixed exchange rate constituted currency manipulation. In November 2004, the Administration rejected a similar petition filed by Members of Congress, while continuing to press and advise China on revaluing or floating its currency. In April 2004, the Bush Administration rejected a Section 301 petition filed by the AFL-CIO alleging unfair trade practices based upon exploitation of labor in the PRC and calling for a tariff of up to 77% on goods imported from China. In July 2006, the USTR rejected another, similar Section 301 petition filed by the AFL-CIO. In March 2004, the Bush Administration filed the United States’ first complaint against China under the WTO’s dispute settlement mechanism, charging that the PRC unfairly taxed imported semiconductors.9 In July 2004, China eliminated the tax breaks for domestically-produced semiconductors.

7 The yuan can fluctuate within a band of 0.3% per day. The exchange rate as of December 2006 was 7.8 yuan to 1.0 U.S. dollar. 8 Doug Palmer, “U.S. Sets Duty of up to 198 Pct on Chinese Furniture,” Reuters News, November 9, 2004. 9 Chris Buckley, “China on Unfamiliar Ground in Trade Fight with U.S.,” New York Times, March 23, 2004.


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Congressional Actions On December 15, 2006, Representative Sander Levin, who is to chair the House Ways and Means Trade Subcommittee in the 110th Congress, declared that he would support policies that would address what many regard as China’s unfair trade advantage, gained largely through the PRC government’s manipulation of the value of its currency. These measures include legislation that would impose countervailing duties against non-market economies such as China’s and the filing of a Section 301 petition requesting the Administration to file a WTO case against China. Senator Max Baucus, incoming Chairman of the Senate Finance Committee, stated that “greater flexibility for China’s currency is long overdue.”10 In the 109th Congress, several bills aimed at reducing the U.S. trade imbalance with the PRC were introduced. These bills addressed issues such as China’s currency practices, other alleged unfair trade practices (including dumping and export subsidies), violation of intellectual property rights, and noncompliance with WTO regulations. The following are selected bills from the 109th Congress related to U.S.-China trade: •

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H.R. 4808 (Jones: Introduced February 28, 2006) To prohibit the importation of motor vehicles of the PRC until the tariff rates that China imposes on motor vehicles of the United States are equal to the rates of duty applicable to motor vehicles of the PRC. S. 2267 (Dorgan/Graham: Introduced February 9, 2006) To withdraw normal trade relations treatment from, and apply certain provisions of Title IV of the Trade Act of 1974 to, the products of the People’s Republic of China. Related bill: H.R. 728 (Sanders). H.R. 3283 (English: Introduced July 14, 2005) Amends the Tariff Act of 1930 to impose countervailing duties on certain merchandise from nonmarket economy countries. Passed in the House on July 27, 2005. Related bill: S. 1421 (Collins). H.R. 1498 (Ryan: Introduced April 6, 2006) To clarify that exchange-rate manipulation by the People’s Republic of China is actionable under the countervailing duty provisions and the product-specific safeguard mechanisms of the trade laws of the United States.

“Levin Says Bernanke Comments Justify CVD Action Against China,” Inside US-China Trade, December 20, 2005; Doug Palmer, “U.S. Lawmakers Urge Action after China Meeting,” Washington Post, December 15, 2006.


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S. 377 (Lieberman: Introduced February 15, 2005) To require negotiation and appropriate action with respect to certain countries that engage in currency manipulation. S. 295 (Schumer/Graham: Introduced February 3, 2005) To authorize the imposition of a 27.5% tariff on goods imported from China unless the President certifies that China has made a good faith effort to revalue its currency to reflect its fair market value. Related bills: S. 14 (Stabenow), H.R. 1575 (Myrick), S.Amdt. 309 (Schumer) to S. 600. H.Con.Res. 33 (Ryan: Introduced January 26, 2005) Urging the President to take immediate steps to establish a plan to adopt the recommendations of the United States-China Economic and Security

Review Commission in its 2004 Report to the Congress in order to correct the current imbalance in the bilateral trade and economic relationship between the United States and China.

SUMMARY OF TRADE DATA What light do the trade data shed on the controversy over economic relations with China? First, China has burst onto the U.S. trading scene in recent years. In 2003, the PRC surpassed Japan to become America’s third largest trading partner, after Canada and Mexico,11 while the United States is the PRC’s second largest trading partner, after the expanded European Union (25 nations).12 In 2005, according to PRC data, EU-China trade was valued at $217.3 billion compared to U.S.-China trade of $211.6 billion.13 China’s largest export market is the United States followed by the EU-25 and Japan. Although China is a new player in international trade, it is taking major shares of markets once dominated either by other countries and U.S. domestic industries. China is the second largest source of U.S. imports of merchandise ($243 billion in 2005) after Canada ($287 billion). PRC imports surpassed those of Mexico in 2003 and of Japan in 2002. China now accounts for over 14% of U.S.

11 12 13

In 2005, U.S.-China trade ($285 billion) nearly reached the value of U.S.-Mexico trade ($290 billion). U.S. Census Bureau, Foreign Trade Statistics. “EU Becomes China’s Biggest Trading Partner — USDA Attache,” Reuters News, February 25, 2005. PRC data. “China 2005 Trade Surplus Jumps to Record High,” Yahoo! Asia News, January 11, 2006.


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imports (2005), up from 12% in 2003, 8% in 1999, and 3% in 1990, although this share still falls short of Japan’s 18% in the early 1990s. Second, the data show that while U.S. trade with China is unbalanced, the same is also true for Europe and Japan, although to a lesser extent. China runs a trade surplus with the world’s three major economic centers. The U.S. bilateral deficit in 2005 ($201 billion), however, was 1.6 times larger than that of the EU15 ($121.8 billion; the EU-25 deficit was $133 billion) and seven times that of Japan ($28.5 billion). (As reported by the United States, EU, and Japan.) Third, the data show that the U.S. trade deficit with China is rising with the overall U.S. trade deficit or growing at a slightly faster rate. Between 1996 and 1998, China’s share of the overall U.S. merchandise trade deficit averaged 24%; between 1999 and 2001, China’s share was 18%, and between 2002 and 2004, 22%. In 2005, the United States trade deficit with China constituted 26% of its global trade deficit. Over the same period, the shares of the U.S. deficit in goods trade accounted for by Japan, the Association of Southeast Asian Nations (ASEAN), and the East Asian newly industrialized countries (NICs) have decreased while the European Union’s share has increased. Fourth, the data show that U.S. exports to China are growing faster than U.S. exports to other nations. U.S. exports to China (up 157% between 2000 and 2005) have grown faster than U.S. exports to Canada (up 19.8% over the same period), Mexico (7.5%), and Japan (-15%), although exports to China have grown from a low base.14 In 2004, China replaced Germany and the United Kingdom to become the 4th largest market for U.S. goods, moving up from 11th place in 1999. The United States exported somewhat more to China ($41.8 billion) than it did to the United Kingdom ($38.6 billion) in 2005. According to Japanese, European, and Korean data, in 2005, Japan was the largest overseas supplier of products to China with $79.9 billion in exports. South Korea and the EU-15 and were the second and third largest exporters to China in 2005 with $69.8 billion and $61.9 billion in exports, respectively.15 Fifth, the U.S. industrial sectors most at risk from import competition from China are generally labor intensive, but China is moving quickly up the technology ladder. The sectors in which the United States runs the largest trade deficits are generally those that depend on abundant and low-cost labor, while the United States accrues surpluses with China in some advanced technology items, such as aircraft, as well as in some agricultural products. In China’s trade with the developed countries, over two-thirds of its exports are “low-end 14 15

U.S. Department of Commerce, International Trade Commission. Global Trade Atlas; “Economy Increasingly Dependent on Mainland Ties,” Nikkei Weekly, June 14, 2004.

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manufactures” — appliances, toys, furniture, footwear, apparel, and plastic goods — while 85% of its imports are capital-intensive machinery and equipment, electronic goods, and natural resource-related products.16 The United States has incurred large trade deficits with China in some high value-added sectors as well. These sectors include office and data processing machines, telecommunications and sound equipment, and electrical machinery and appliances. In 2003, China became the third largest car market and the fourth largest maker of automobiles with an output of 4.4 million vehicles. Production of cars reached an estimated 5.5 million units in 2005, putting the PRC on par with Germany in automobile production. However, China is not a major global importer or exporter of cars and it remains heavily reliant upon foreign technology in this sector.17 Sixth, PRC data show much smaller bilateral trade deficits than those claimed by its trading partners. PRC trade data differ from U.S. data primarily because of the treatment of products from or to China (mainland) that pass through the Hong Kong Special Administrative Region (SAR). Other reasons include different accounting systems and a lack of transparency in China’s data reporting. China counts Hong Kong as the destination of its exports sent there, even goods that are then transshipped to other markets. By contrast, the United States and many of China’s other trading partners count Chinese exports that are transshipped through Hong Kong as products from China,18 not Hong Kong, including goods that contain Hong Kong components or involve final assembly or processing in Hong Kong. Furthermore, the United States counts Hong Kong as the destination of U.S. products sent there, even those that are then re-exported to China. However, the PRC counts many of such re-exported goods as U.S. exports to China. Some analysts argue that the U.S. Department of Commerce overstates the U.S. trade deficit with China by as much as 21% because of the way that it calculates entrepot trade through Hong Kong.19 According to PRC data, China’s trade surplus with the United States in 2005 was $114 billion — not $201 billion as reported by the United States government. In Japan’s case, both countries claim to be running trade deficits with each other. According to PRC data, in 2005, China ran deficits with many of its major trading 16

Jonathan Anderson, “China, Asia’s Paper Tiger?” The Asian Wall Street Journal, August 15, 2002. “China to Become 2nd Largest Automaker by 2010,” Asia Times Online [http://www.atimes.com], August 25, 2005; Xinhua News Agency, April 11, 2005. 18 According to the Hong Kong Trade Development Council, 55% of Hong Kong’s total exports involve re-exports of Chinese (mainland) goods to markets other than China. 19 U.S.-China Business Council, “Understanding the U.S.-China Balance of Trade,” May 2003. 17


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partners, including Taiwan ($57.9 billion), South Korea ($41.7 billion), Japan ($16.3 billion), Malaysia ($9.5 billion), Saudi Arabia ($8.4 billion), Philippines ($8 billion), Thailand ($6 billion), Australia ($5 billion), Brazil ($5 billion) Iran ($3.5 billion).20 Seventh, some trade specialists suggest that the surge of U.S. imports from China do not pose an additional threat to U.S. industries and workers because it merely represents a shift of investment and production from other Pacific Rim countries. China’s share of U.S. imports has been rising while those of other Pacific Rim nations have been falling or holding steady. In terms of absolute values, until recently, U.S. imports from all major Pacific Rim countries continued to rise, although at slower rates than imports from China. In 2005, U.S. imports from the East Asian NICS — South Korea, Taiwan, Hong Kong, and Singapore — fell or barely rose from the previous year. Eighth, the rapid growth of the Chinese economy is adding to world demand for basic commodities that is causing upward pressure on world prices. Particularly significant are Chinese net imports of crude oil, copper, and soybeans.

CHINA’S TRADE BALANCE AND IMPORTS As shown in Figure 1 and Appendix Table A1, according to PRC data, with the exception of 1993, China has run a global trade surplus in goods each year since 1990. That surplus emerged at the beginning of the 1990s, entered into a deficit of $11 billion in 1993 (when the government temporarily loosened controls on imports), and reached a peak of $43.3 billion in 1998 before declining to $22.6 billion in 2001. In 2005, China’s global trade surplus leapt to $102 billion (PRC data). Between 1995 and 2001, China’s current account surplus (includes trade in goods, services, and unilateral transfers such as remittances and government to government payments) was smaller than its surplus in merchandise trade because of a deficit in its services trade. Since 2002, the current account surplus has exceeded the merchandise trade surplus due to large increases in services exports and remittances. In 2005, the current account surplus was $160.8 billion compared to the merchandise trade surplus of $102 billion. According to one projection, China’s global current account balance will remain in surplus “for

20

Global Trade Atlas.


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some years to come,” due to continued high rates of foreign investment, strong exports, and excessive savings in the non-state sector.21 800

$Billions

600

Exports

400

200

Imports

0

-200

83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 0 1 2 3 4 5 Year

Sources: PRC General Administration of Customs; Global Trade Atlas (PRC data).

Sources: PRC General Administration of Customs; Global Trade Atlas (PRC data). Figure 1. China’s Exports, Imports, and Balance of Merchandise Trade, 1983-2005 (PRC data)

As mentioned in the previous section, PRC data show much smaller bilateral trade deficits than those claimed by its trading partners. In 2005, the United States claimed it had incurred a $201 billion trade deficit with China, while China reported a trade surplus of only $114 billion with the United States. Japan reported a $28.5 billion merchandise trade deficit with China, while China likewise claimed a $16.3 billion trade deficit with Japan. In 2005, the European Union’s trade deficit with China ($121.8 billion) was only $63 billion according to Chinese data. In 2005, the 156 countries categorized as the “world” by the International Monetary Fund reported an aggregate trade deficit with China of $342 billion. This is approximately 3.3 times the $102 billion global merchandise trade deficit reported by China for that year.22 (See Appendix Tables A1-A5.) Not only have the surge in imports from China affected U.S. markets, but China has become a major importer of world commodities or primary goods. Table 1 shows China’s imports by major commodity. Imports of machinery (including electrical) have soared from a total of $63.1 billion in 1999 to $271.3 21

Global Insight, “China: Interim Forecast Analysis,” June 2006, and “China: Economic: Current Situation: Highlights,” August 2006. 22 U.S. Department of Commerce, International Trade Commission; Global Trade Atlas; International Monetary Fund, Direction of Trade Statistics Quarterly, June 2006.


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billion in 2005. Such an increase in demand for machinery, however, has only a moderate effect on overall prices. China’s imports of mineral fuel, organic chemicals, iron and steel, ores, copper, cotton, and wood, however, can affect world prices, particularly when combined with rising world demand or tightening supplies. In 2004-2005, Chinese demand for mineral fuel, in particular, including crude petroleum added to upward world price pressures. Table 1. China’s Imports by Major Commodity, 1999-2005 (billions of dollars)

Electrical Machinery Machinery Mineral Fuel, Oil, etc. Optics, Medical. Instr. Plastic Organic Chemicals Iron and Steel Ores, Slag, Ash Copper & Articles Thereof Vehicles, Not Railway Misc. Grain, Seeds, Fruit Cotton and Yarn, Fabric Aircraft, Spacecraft Paper, Paperboard Misc. Chemical Products Wood, Articles of Wood

1999 2000 2001 2002 2003 2004 2005 35.3 50.7 55.9 73.3 104.0 142.1 174.9 27.8 34.4 40.6 52.2 71.6 91.5 96.4 8.9 20.7 17.5 19.3 29.3 48.0 64.2 5.0 7.3 9.8 13.5 25.1 40.1 49.9 11.6 14.5 15.3 17.4 21.0 28.0 33.3 5.5 8.3 9.0 11.2 16.0 23.8 28.0 7.2 9.6 10.9 13.2 22.2 23.6 26.2 2.2 3.1 4.2 4.3 7.2 17.3 25.9 3.1 4.7 4.9 5.7 7.2 10.5 12.9 2.4 1.6 2.4 3.2 1.6 2.2 2.9

3.6 3.1 2.8 2.2 2.6 2.5 3.7

4.5 3.3 2.9 4.4 2.7 2.6 3.5

6.5 2.8 3.3 4.1 2.9 3.8 4.1

11.8 5.7 4.7 4.5 3.9 4.9 4.6

12.9 7.3 6.9 4.9 5.2 5.1 5.2

12.2 8.1 7.0 6.6 6.3 6.0 5.7

Source: Global Trade Atlas using Chinese data.

CHINA AND THE ASIA PACIFIC REGION While China is gaining manufacturing prowess and its trade surplus with the United States is spiraling, the country is purchasing heavily from neighboring trading partners. In 2004, China’s imports rose by 35%, including machinery, raw materials, and components for manufacturing, although this growth in

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imports slowed to 17% in 2005.23 In addition, the bulk of China’s exports are manufactured under foreign brand names, and over half of China’s exports are produced by foreign-owned companies. According to PRC official estimates, 70% of PRC exports to the United States contain foreign components, particularly from Taiwan, South Korea, and Singapore.24 China (not including Hong Kong) has become the largest trading partner of Taiwan and the second largest trading partner of Japan. The PRC has become South Korea’s largest foreign investment destination and largest export market. According to Taiwanese and Korean data, in 2005, Taiwan’s estimated trade surplus with China was $31.9 billion, while South Korea’s surplus was $31.2 billion.25 China has become a huge buyer of raw materials, agricultural commodities, industrial machinery, and electronic components from Southeast Asia, as well as an important source of foreign investment and second largest source of foreign tourists in the region.26 China’s top exports to Southeast Asia include machinery, electronic goods, iron and steel, mineral fuels, textiles and apparel, and optical, photographic, and medical equipment. Despite worries about economic competition, in 2004, ASEAN, which ran a trade surplus of $20 billion with China that year (PRC data),27 agreed to establish a free trade zone with China which would be implemented gradually over five years.28 In the view of many of its major trading partners in Asia, China’s economic growth and open trade policies have presented both competitive challenges and economic opportunities. However, according to some analysts, China’s appetite for imports is slowing, while its export production shows little sign of abating.29 Although ASEAN accumulated a trade surplus with China again in 2005 ($19.5 billion, according to PRC data), China’s exports to ASEAN grew 50% faster than its imports from Southeast Asia. 23

Robert J. Samuelson, “The World’s Powerhouse,” Newsweek, May 31, 2004. Taiwan’s major exports to China include telecommunications products, computers, plastic products, steel, man-made fibers, industrial-use textiles, organic chemical products, optical and photo-taking instruments and parts, copper products, and polyester. Hong Kong Trade Development Council. 25 When Hong Kong is included, China is the largest trading partner of both Taiwan and Japan. Directorate General of Customs, Ministry of Finance, Republic of China; Korean International Trade Association; Global Trade Atlas. 26 Sadanand Dhume, “Buying Fast into Southeast Asia,” Far Eastern Economic Review, March 28, 2002. 27 Global Trade Atlas 28 “China-ASEAN Trade Surges over 40 Percent in 2003,” Thai News Service, February 11, 2004. 29 Keith Bradsher and David Barboza, “As Exports Boom, China Risks Global Backlash,” International Herald Tribune, April 9, 2005. 24


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Figure 2. Shares of Total U.S. Imports by Country and Country Group, 1990 and 2005

Some trade specialists suggest that the surge of U.S. imports from China do not pose an additional threat to U.S. industries and workers because it merely represents a shift of investment and production from other Pacific Rim countries. In other words, expanding imports from China have been offset by declining imports from other East Asian or Pacific Rim countries.30 These countries include those at a similar level of development which are competing directly with China, such as Malaysia and Thailand, and more industrialized countries or special administrative regions that have moved their lower-end production to the PRC, such as Macao, Hong Kong, South Korea, and Taiwan. In sectors such as footwear, handbags, apparel, furniture, and building and lighting fixtures, U.S. imports from China have been displacing those from Hong Kong, South Korea, Taiwan, and Mexico and reducing imports those from other developing Asian nations. As shown in Figure 2, China’s share of U.S. imports grew from 3% in 1990 to 14% in 2005 (out of total U.S. imports of $491 billion and $1.66 trillion, respectively),31 while the rest of East Asia’s share (Japan, NICS,32 and ASEAN) fell from 36% to 19%. Mexico’s share of U.S. imports grew from 6% in 1990 to 11.6% in 2002. It fell to 10.6% in 2004 and further to 10.1% in 2005.

30

Council of Economic Advisors, Economic Report of the President, February 2004. U.S. Imports for Consumption, U.S. International Trade Commission. 32 NICS — Hong Kong, Taiwan, and South Korea (Singapore is counted in ASEAN). 31


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CHINA’S TRADE WITH THE UNITED STATES, EUROPE, AND JAPAN As shown in Figure 3 and Appendix Table A2, by either Chinese or U.S. data, China runs a trade surplus with the United States. Although Chinese figures show it at only $114 billion in 2005, the United States reports it to be $201 billion. According to PRC data, China has run a trade surplus with the United States since 1993. According to U.S. data, the United States has incurred trade deficits with China since 1983. 300

$Billions

Imports

200 100

(U.S. figures)

Exports

(U.S. figures)

0 -100 -200 -300

Balance

(U.S. figures)

Balance (PRC data)

83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 0 1 2 3 4 5 Year

Sources: U.S. Department of Commerce IMF. Direction of Trade Statistics Yearbook Global Trade Atlas

Sources: U.S. Department of CommerceIMF. YearbookGlobal Trade Atlas

Direction of Trade Statistics

Figure 3. U.S. Exports, Imports, and Balance of Trade with China, 1983-2005

As is the case with the United States, Japan has run a trade deficit with China since the 1980s (according to Japanese data). As shown in Figure 4 and in Appendix Table A3, Japan’s balance of trade with China dropped from a surplus of $6 billion in 1985 to a deficit of nearly $6 billion in 1990. Japan’s trade deficit with China reached a peak of $26.5 billion in 2001, which was surpassed in 2005 ($28.5 billion). Japan’s exports to China have grown dramatically in the past few years, its largest exports to the PRC being electronics, general machinery, iron and steel, optical, photographic, and medical equipment, and organic chemicals.33 As shown in Figure 5 and Appendix Table A4, according to EU data, the European Union incurred a trade deficit with China of $947 million in 1988, which grew to $121.8 billion in 2005. According to Chinese figures, however, the EU trade deficit with China began in the late 1990s and grew to $63 billion in 2005. 33

Global Trade Atlas.

China’s Trade with the United States and the World 120

133

$Billions

100

Imports

80

(Japan's Data)

60

Exports

(Japan's Data )

40

Balance

(China's Data)

20 0 -20 -40

Balance

(Japan's Data) 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 0 1 2 3 4 5 Year

Sources: IMF.Direction of Trade Statistics Quarterly Global Trade Atlas

Sources: IMF. Direction of Trade Statistics Quarterly Global Trade Atlas Figure 4. Japan’s Merchandise Imports, Exports, and Balance of Trade with China, 19832005

Compared to the world’s two other major economic centers, the U.S. trade deficit with China at $201 billion in 2005 was the largest, followed by the EU-15 deficit with China at $121.8 billion and Japan at $28.5 billion. Within the EU, according to trading partner 2005 data, Germany’s trade deficit with China was $23 billion, the U.K.’s was $18.8 billion, and France’s was $9.9 billion. As shown in Appendix Table A5, however, China’s trade statistics indicate smaller European trade deficits or even surpluses. 200 150 100 50

$Billions

Imports

(EU/EEC Data)

Exports

(EU/EEC Data)

0 -50 -100 -150

Balance

(China's Data)

Balance

(EU/EEC Data) 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 0 1 2 3 4 5 Year

Note: For 1980-88, data are for the EEC12 nations. After 1988, data are for the EU 15. Sources: IMF.Direction of Trade Statistics Quarterly Global Trade Atlas

Note: For 1980-88, data are for the EEC12 nations. After 1988, data are for the EU 15.Sources: IMF. Direction of Trade Statistics QuarterlyGlobal Trade Atlas Figure 5. European Union Merchandise Imports, Exports, and Balance of Trade with China, 1983-2005

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U.S. MERCHANDISE TRADE BALANCES WITH MAJOR TRADING PARTNERS The U.S. trade deficit with China is notable for not only its size but also the large imbalance between imports from and exports to China. In 2005, Japan exported 2.5 times more to the United States than it imported, while Canada and Mexico exported 1.3 times and 1.4 times more, respectively, than they imported. China, by comparison, exported 5.8 times more to the U.S. market in 2005 than it imported from the United States. This indicates that the Chinese market has been vastly underdeveloped as a destination for U.S. exports.

Source: U.S. Department of Commerce Figure 6. U.S. Merchandise Trade Balances with Selected Countries in 2005

U.S. TRADE WITH CHINA BY SECTOR U.S. Exports to China As shown in Table 2, among the top twenty U.S. exports to China in 2005, the top five by dollar value were electrical machinery, transport equipment,


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metalliferous ores, oil seeds and fruits, and general industrial machinery. Exports of metalliferous ores and oil seeds and fruits have grown by over 12 times and 6 times, respectively, since 1999, suggesting that China’s appetite for raw materials and agricultural commodities has grown relative to that for general industrial machinery and office machines. Among the top 20 U.S. export items to China, textile fibers have experienced the largest growth in the past five years (969%). China’s top ten imports from the world in 2005 were: electrical machinery, machinery, mineral fuels, optical and medical instruments, plastics, organic chemicals, iron and steel, iron ores, copper articles, and vehicles. Table 2. Top Twenty U.S. Exports to China, 1997-2005 (millions ofdollars) Category 1997 1998 1999 2000 2001 2002 2003 2004 2005 Electrical Mach. 741 1,013 1,380 1,747 2,109 2,657 3,722 4,631 5,170 Transport Equip. 2,127 3,604 2,325 1,695 2,471 3,443 2,495 2,025 4,479 Metalliferous Ores 180 195 285 618 919 956 1,525 2,198 3,482 288 354 1,020 1,014 890 2,832 2,332 2,256 Oil Seeds and Fruits 419 Gen. Ind. 766 674 685 838 1,080 1,145 1,404 1,912 2,067 Mach./Equip. Office Machines 343 878 842 1,498 1,602 1,193 1,274 1,396 1,835 Plastics in Prim. 340 320 394 545 628 740 931 1,342 1,793 Forms Prof. & Scientific 429 527 538 583 886 931 1,167 1,568 1,710 Instr. Textile Fibers 682 199 98 154 160 278 909 1,638 1,657 212 302 473 373 554 1,054 1,542 1,457 Organic Chemicals 208 Specialized Industrial 770 538 481 758 819 1,124 1,218 1,744 1,325 Machinery Telecom, Sound 644 655 573 817 1,204 1,110 978 1,104 1,299 Recording Equip. 542 505 312 507 462 640 965 1,042 Power Gen. Equip. 603 156 193 276 330 414 600 753 992 Pulp and Waste Paper 148 Road Vehicles 348 140 192 185 223 272 506 624 903 120 140 289 144 161 315 333 872 Nonferrous Metals 172 Misc. Manufactures 297 247 242 384 440 509 515 647 750 126 96 237 402 397 457 521 629 Hides, Furskins 112 Chemical Materials 124 143 177 247 285 312 403 582 604 190 162 211 265 367 304 618 547 Metalworking Mach. 173

Note: Ranked by data for 2005. Source: U.S. Department of Commerce, International Trade Commission.

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U.S. IMPORTS FROM CHINA As shown in Figure 7 and Table 3, among the top twenty U.S. imports from China in 2005 by dollar amount, the top six were office machines and automatic data processing machines, telecommunications and sound equipment, miscellaneous manufactured articles, apparel and accessories, electrical machinery, and furniture and bedding. The value of U.S.-imports of PRC office and data processing machines alone ($42.2 billion) exceeded total U.S. exports to China in 2005 ($41.8 billion). While U.S. imports in all these categories have increased, the most dramatic percentage changes have been not in traditional labor-intensive industries but in sectors that encompass advanced technology, such as office and data processing machines (up 284% between 2000 and 2005), telecommunications and sound equipment (245%), and general industrial machinery (234%).

Source: U.S. Dept. of Commerce. Figure 7. Top Six Imports from China by Industry, 1994-2005

Table 3. Top Twenty U.S. Imports from China, 1997-2005 Category Office Machines, Data Processing Telecom and Sound Equip. Misc. Manufactured Articles Apparel and Accessories Electrical Machinery, Parts, and Appliances Furniture and Bedding Footwear Manufactures of Metals General Industrial Machinery Textile Yarn, Fabrics Travel Goods, Handbags Road Vehicles Building Fixtures/Fittings Nonmetallic Mineral Manufactures Professional & Scientific Instruments Iron and Steel Photographic Optical Equip, Watches, Clocks Misc. Low-Valued Items Cork and Wood (Non-Furniture) Organic Chemicals

(millions of dollars) 1999 2000 8,239 10,980

1997 5,019

1998 6,329

2001 10,763

2002 15,230

2003 23,646

2004 35,620

2005 42,242

5,126 14,155 7,406 4,877

6,405 15,872 7,133 5,707

7,382 17,291 7,351 7,022

9,812 19,445 8,473 9,037

10,118 19,763 8,866 9,110

14,144 23,494 9,538 10,217

16,937 26,287 11,381 11,875

24,388 29,505 13,607 15,270

34,249 33,573 19,931 18,102

1,545 7,354 1,816 1,180 1,369 1,917 574 1,194 1,216

2,183 8,016 2,238 1,449 1,432 1,942 731 1,444 1,441

3,261 8,438 2,878 1,833 1,583 1,974 923 2,073 1,681

4,476 9,206 3,651 2,087 1,816 2,214 1,800 2,555 2,059

5,018 9,758 4,119 2,414 1,854 2,171 1,406 2,377 2,165

6,954 10,241 5,219 3,259 2,501 2,741 1,796 2,962 2,431

8,749 10,546 6,302 41,213 3,365 3,319 2,373 3,202 2,624

10,910 11,350 8,257 5,528 4,253 4,044 3,265 3,700 2,953

13,187 12,721 10,110 7,007 5,605 4,658 4,170 4,143 3,510

634

715

837

1,025

1,177

1,301

1,666

2,180

2,490

314 1,211

398 1,400

349 1,600

623 2,016

439 1,935

441 1,842

483 2,030

1,609 2,248

2,354 2,176

282 335 335

425 445 337

586 568 392

759 710 467

784 792 488

957 990 564

1,229 1,162 772

1,652 1,612 1,071

2,068 2,006 1,600

Table 3. Continued Category Power Generating Machinery Paper Products

1997 314 310

1998 354 401

(millions of dollars) 1999 2000 408 505 471 611

Note: Ranked by data for 2005. Source: U.S. Department of Commerce, International Trade Commission.

2001 553 627

2002 694 792

2003 842 1,022

2004 1,112 1,263

2005 1,573 1,535


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BALANCE OF TRADE BY SECTOR In modern economies, trade by sector generally follows two patterns. The first is based on traditional comparative advantage in which one country trades with another in those products in which it has an abundance of resources or in which it is comparatively productive. The United States economy is characterized by high technology, extensive farmland with high agricultural yields, expensive labor, and deep capital. As such, the United States would be expected to be strong in exports of high-technology goods, food and grains, and capital intensive products. The Chinese economy, on the other hand, is characterized by abundant and cheap labor, low capital intensity, and a mix of low, medium and high technology both in manufacturing and agriculture. As such, China would be expected to be strong in exports of not only labor-intensive manufactures, such as textiles and apparel, shoes, toys, and light manufactures, but also items produced under the tutelage of foreign companies that have invested in Chinese factories. These could include household appliances, electronics, tools, or automobile parts. One would expect trade that is conducted on the basis of comparative advantage to be unbalanced on a sector-by-sector basis. The United States, for example, would run a surplus with China in aircraft but a deficit in apparel. The second trade pattern occurs among industrialized countries and is called intra-industry or trade within industrial sectors. This is typical of trade among North America, the European Union, and industrialized nations of Asia (e.g., Japan, South Korea, and Taiwan). The products traded usually carry brand names, are differentiated, and may be protected by intellectual property rights. For example, the United States both imports and exports items such as automobiles, machinery, electronic devices, prepared food, and pharmaceuticals. A considerable share of U.S. intra-industry trade is carried out within a multinational corporation (e.g., between Ford Motors and one of its related companies, such as Mazda in Japan, Jaguar in the United Kingdom, or with other subsidiaries abroad). A large deficit in an intra-industry trading sector in which the United States is competitive may indicate that the trading partner country is using import barriers to tip the trade balance in its favor. Table 4 shows the U.S. balance of trade with China by major sector. Most of the sectors in which the United States runs the largest trade deficits with China are, as expected, those that depend on mostly abundant and low-cost labor. These include toys and sports equipment, furniture and bedding, footwear, textiles and apparel, and leather goods. Among the large deficit sectors, however, are machinery and mechanical appliances and electrical machinery, which reflect China’s foreign investment and growing technological sophistication. In plastic


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articles, optical and medical instruments, books and magazines (indicated by shading in the table), the United States runs a surplus in its balance of trade with the world but a deficit with China. Table 4. U.S. Balance of Trade with China by Sector, 2003-2005

Total China

(millions of dollars) 2003 -123,960

2004 161,977

2005 201,625

-25,262 -24,007 -16,070 -11,739 -10,528 -5,484 -3,192 -5,040 -3,086 -3,032 -2,353 -1,947 -1,414 -1,391 -1,019 -1,373 -1,650 -698 -1,023 -1,112 -1,091 -653

-37,628 -34,113 -17,163 -14,339 -11,318 -6,606 -4,092 -5,708 -4,376 -3,402 -3,052 -2,729 -1,809 -1,714 -1,454 -1,554 -1,704 -1,036 -1,203 -1,203 -1,109 -892

-46,375 -46,249 -19,074 -16,942 -12,679 -10,220 -6,553 -6,247 -5,886 -4,380 -3,953 -3,268 -2,243 -2,065 -1,847 -1,774 -1,729 -1,551 -1,404 -1,316 -1,145 -1,130

2,388 2,787 587 599 477

1,870 2,260 1,260 752 527

4,296 2,165 1,215 990 624

Major U.S. Deficit Sectors (HTS Categories) Machinery/Mechanical Appliances Electrical Machinery Toys and Sports Equipment Furniture and Bedding Footwear Woven Apparel Knit Apparel Leather Art; Saddlery; Bags Articles of Iron and Steel Plastic Articles Misc. Textile Articles Vehicles, Not Railway Misc. Art of Base Metal Precious Stones and Metals, Pearls Wood and Articles of Wood Tools, Cutlery, of Base Metals Optical, Medical Instruments Rubber and Rubber Articles Miscellaneous Manufactures Ceramic Products Artificial Flowers, Feathers Books, Newspapers, Manuscripts Major U.S. Surplus Sectors (HTS Categories) Aircraft, Spacecraft Misc. Grain, Seed, Fruit Cotton and Cotton Fabrics Wood pulp, Etc. Hides and Skins


Total China Copper and Articles Thereof Ores Iron and Steel

(millions of dollars) 2003 -123,960 436 34 879

2004 161,977 344 105 45

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2005 201,625 545 373 336

Note: Categories in italics are those in which the United States runs a trade surplus with the world but a trade deficit with China. Classification is by Harmonized System tariff codes at the 2-digit level. Source: U.S. Department of Commerce, International Trade Commission.

The sectors in which the United States runs a trade surplus with China mirror U.S. competitive advantages and include aircraft, agricultural products, and cotton fabrics. In 2005, U.S. trade surpluses with China in aircraft, copper, iron ores, and iron and steel rose dramatically.

U.S. IMPORTS FROM CHINA — SECTOR CHARTS AND DATA This section presents charts and data on U.S. imports from China by selected industrial sectors. The charts show imports from China as compared with imports from other major exporting countries or groups of countries. These include the European Union (fifteen original countries), the Association of Southeast Asian Nations (ASEAN, which includes, Indonesia, Malaysia, Singapore, Thailand, the Philippines, Brunei, Vietnam, Laos, and Myanmar [Burma]), Taiwan, Mexico, South Korea, Japan, Hong Kong, and Canada. The data in this section are presented according to two-digit standard international trade classification (SITC) codes as reported by the U.S. Department of Commerce. The industries selected are those in which the share of imports from China has risen to a significant level or trade policy has played a significant role (e.g. iron and steel and automobiles) even though U.S. imports from China in those industries might be relatively small.

Iron and Steel In iron and steel products, China is becoming a major exporter to the United States. In 2005, China was the fourth largest foreign supplier of iron and steel products to the United States (surpassing Russia, South Korea, Germany, and


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Japan), up from seventh place in 2003. In 2005, China also bought $445 million worth of iron and steel products from the United States, making it the third largest market for U.S. exports of iron and steel. In 2005, the United States incurred a trade deficit with China in the SITC 67 category (iron and steel), which includes semi-finished products, tubes and pipes, iron and steel rods, and ferroalloys. However, the United States attained a trade surplus with China in the HTS 72 category (iron and steel), which includes more items in “primary form.”

Source: U.S. Dept. of Commerce. Figure 8. U.S. Imports of Iron and Steel Products (SITC 67) by Country and Group, 19902005

Table 5. U.S. Imports of Iron and Steel Products (SITC 67) from Selected Countries and Country Groups, 1991, 2000-2005 1990 EU15 Canada Mexico China Japan Korea Taiwan ASEAN Hong Kong Rest of World World

(millions of dollars) 2001 2002 2003 2004 2005 3,303 3,637 3,041 2,621 4,697 5,828 2,885 3,979 4,699 1,504 2,437 2,981 357 1,021 1,340 1,334 2,530 2,738 490 1,610 2,340 71 439 441 2,097 1,213 991 799 1,072 1,468 505 1,031 1,374 574 815 687 154 346 290 219 803 735 161 395 406 65 191 193 2 2 3 2 3 10 3,929 10,204 9,034 1,691 3,657 4,469 9,818 13,758 14,436 12,945 26,324 28,632

Source: U.S. Department of Commerce


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Specialized Industrial Machinery China is becoming an important supplier of specialized industrial machinery, which includes machine tools and sewing machines, but lags behind the European Union, Japan, and Canada and competes with other newly industrialized countries such as Mexico, South Korea, and Taiwan. China accounted for only 4.5% of U.S. imports in this category in 2005.

Source: U.S. Department of Commerce Figure 9. U.S. Imports of Specialized Industrial Machinery (SITC 72) by Country and Group, 1990-2005

Table 6. U.S. Imports of Specialized Industrial Machinery (SITC 72) from Selected Countries and Country Groups, 1990, 2001-2005

1990 EU15 Japan Canada China Mexico Korea Taiwan ASEAN

(millions of dollars) 2001 2002 2003 2004 2005 6,786 9,511 8,463 9,586 11,656 13,419 3,340 4,479 4,217 4,445 6,105 7,019 3,482 1,384 2,297 2,294 2,556 3,010 23 331 485 791 1,069 1,415 139 537 490 578 862 1,241 69 305 325 467 746 1,159 638 623 730 684 313 626 13 101 113 145 250 287


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Table 6. Continued

1990 Hong Kong Rest of World World

(millions of dollars) 2001 2002 2003 2004 2005 18 12 17 15 18 17 868 1,314 1,373 1,614 2,049 2,464 12,953 19,513 18,415 20,820 26,495 31,187


Office Machines and Computers In U.S. imports of office machines and automatic data processing machines (including television sets, computers and computer hardware), China has quickly become the largest supplier, surpassing ASEAN. Imports of such products from China rose by over 75% between 2003 and 2005 and now account for 42% of U.S. imports in this category. Office machines and computers from other East Asian countries — Japan, Taiwan, and South Korea — have been leveling off or decreasing, although many of their high tech manufacturers have built plants in China and export from there. The top exporters of office machines and data processing machines to the United States in 2005 were China, Malaysia, Japan, Mexico, and Singapore.

Source: U.S. Department of Commerce. Figure 10. U.S. Imports of Office Machines and Automatic Data Processing Machines (SITC 75) by Country and Group, 1990-2005


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Table 7. U.S. Imports of Office Machines and Automatic Data Processing Machines (SITC 75) from Selected Countries and Country Groups, 1990, 2001-2005 (millions of dollars) 1990 2001 2002 2003 2004 China 117 10,761 15,230 23,612 35,579 ASEAN 5,150 20,676 22,043 21,571 22,460 Japan 11,007 11,055 9,464 8,978 9,282 Mexico 706 10,377 8,828 7,516 7,726 Taiwan 3,084 8,751 8,659 6,996 6,132 EU15 2,461 4,676 4,505 4,815 4,810 Korea 1,347 4,657 4,632 3,779 3,885 Canada 1,893 2,942 1,825 1,644 1,865 Hong Kong 809 276 392 328 304 Rest of World 297 1,729 1,342 2,947 1,492 World 26,871 75,900 76,920 80,542 93,535 Source: U.S. Department of Commerce

2005 42,169 23,473 8,936 7,075 4,879 4,516 3,104 1,966 210 2,015 98,343

Source: U.S. Department of Commerce. Figure 11. Imports of Telecommunications and Sound Equipment (SITC 76) by Country and Group, 1990-2005

Telecommunications and Sound Equipment China’s share of U.S. imports of telecommunications and sound equipment has risen to 33%. Such imports from China rose from $1.1 billion in 1990 to $34


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billion in 2005. Imports of these products from elsewhere in Asia, particularly from ASEAN countries, have also been rising rapidly. The largest suppliers of telecommunications and sound equipment to the United States in 2005 were China, Mexico, Malaysia, Japan, and South Korea. Table 8. U.S. Imports of Telecommunications and Sound Equipment (SITC 76) from Selected Countries and Country Groups, 1990, 2001-2005

1990 China Mexico ASEAN Korea Japan EU15 Canada Taiwan Hong Kong Rest of World World

(millions of dollars) 2001 2002 2003 2004 2005 34,140 1,142 10,062 14,144 16,723 24,311 18,840 2,302 15,765 14,483 14,239 17,475 8,548 9,514 10,218 11,779 17,114 3,122 6,001 6,353 7,955 10,942 8,214 1,632 8,577 8,473 8,889 9,967 9,707 9,061 3,883 4,559 4,051 3,707 4,382 890 4,533 3,543 3,053 3,435 4,103 972 2,361 2,137 2,655 3,261 4,125 1,426 224 357 522 647 672 478 2,446 2,264 2,363 1,941 2,637 322 103,934 21,347 62,400 65,827 70,668 87,465


Source: U.S. Department of Commerce Figure 12. U.S. Imports of Electrical Machinery and Parts (SITC 77) by Country and Group, 1990-2005


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Electrical Machinery and Parts U.S. imports of electrical machinery and parts (including semi-conductors) have been growing dramatically from nearly all major suppliers. At 18% of such imports in 2005, China has become a significant supplier — surpassing the EU, Japan, and ASEAN. Mexico remains the leading foreign supplier. Table 9. U.S. Imports of Electrical Machinery and Parts (SITC 77) from Selected Countries and Country Groups, 1990, 2001-2005 1990 Mexico China EU15 ASEAN Japan Canada Taiwan Korea Hong Kong Rest of World World

(millions of dollars) 2001 2002 2003 2004 2005 4,406 16,290 16,930 17,547 19,120 652 9,047 10,217 11,808 15,197 4,898 11,009 10,881 11,462 12,314 4,644 13,748 12,427 11,308 11,557 8,658 11,941 9,406 8,713 10,251 3,323 5,871 5,025 4,920 5,619 2,180 5,878 5,296 5,160 6,170 2,504 5,194 5,150 5,105 5,992 792 1,050 881 585 637 1,080 4,112 4,359 4,916 5,414 33,137 84,140 80,572 81,524 92,271

20,671 17,980 13,360 11,736 10,665 6,210 6,077 5,437 593 5,560 98,289


Road Motor Vehicles China is the world’s third largest auto market and fourth largest auto producer. China’s automobile sector has absorbed heavy foreign investment — roughly 70% of the country’s car market is held by Chinese-foreign joint ventures such as Shanghai General Motors (GM), Shanghai Volkswagen, and First Auto Works-Toyota — and is aimed primarily at Chinese buyers.115 China became a net exporter of vehicles for the first time in 2005, with exports of 172,800 vehicles and imports of 161,900 units. Most of China’s vehicle exports are sold in Middle Eastern, North African, and South American countries. In addition, China has become a major supplier of motorcycles to Southeast Asia. Chinese auto makers 115

In 2005, GM sold more than 650,000 vehicles in China compared to Volkswagen, with sales of 500,000 cars, and Toyota, with 179,000 units. “Toyota in China: Full Speed Ahead,” BusinessWeek Online, March 9, 2006.

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Geely and Chery reportedly have plans to begin exporting passenger cars to the United States in 2007 or 2008.116 Currently, China is not a significant player in the U.S. car market. U.S. road vehicle and related imports from China mainly consist of auto parts, bicycles and motorcycles, and specialty vehicles such as golf carts and beach go-carts. China has become an important supplier of auto parts to the United States, with $2 billion in selected auto parts in 2005, but trails Canada ($11.8 billion), Japan ($8.8 billion), Mexico ($7.7 billion), and Germany ($2.3 billion). China exported $290 million worth of motorcycles to the United States in 2005, accounting for 8% of U.S. motorcycle imports compared to Japan’s 73%. China is expected to continue to lower tariffs on imported automobiles, to 25% in 2006, pursuant to China’s WTO accession agreement, although many nontariff barriers reportedly remain.117

Source: U.S. Department of Commerce. Figure 13. U.S. Imports of Road Motor Vehicles (SITC 78) by Country and Group, 19902005

116

“Chinese Automaker Geely Sets Sights on Exports to U.S.” Associated Press Newswires, January 11, 2006. 117 “MOC: Tariff Cut to Put Little Effect on Imported Car Price next Year,” Xinhua News Agency, December 19, 2005.


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Table 10. U.S. Imports of Road Motor Vehicles (SITC 78) from Selected Countries and Country Groups, 1990, 2001-2005

Canada Japan EU15 Mexico Korea China Taiwan ASEAN Hong Kong Rest of World World

(millions of dollars) 1990 2001 2002 2003 2004 2005 61,332 26,094 50,477 52,050 52,448 58,832 29,839 41,429 45,449 43,178 45,033 48,867 12,270 28,022 31,043 35,975 37,813 39,958 4,084 26,246 26,181 25,222 26,114 26,744 1,275 6,778 7,382 8,503 10,773 10,187 59 1,404 1,796 2,369 3,267 4,198 871 1,124 1,239 1,387 1,522 1,804 88 247 280 297 359 432 7 13 14 38 43 39 930 2,892 3,338 4,271 4,412 3,853 75,517 158,632 168,772 173,688 188,168 197,414


Source: U.S. Department of Commerce. Figure 14. U.S. Imports of Building and Lighting Products (SITC 81) by Country and Group, 1990-2005


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Building and Lighting Products In U.S. imports of prefabricated buildings, sanitary, plumbing, heating and lighting fixtures and fittings, China has surged to become a main factor. The PRC accounted for over half such imports in 2005, although total imports of such products from China amounted to only $4 billion, making it the 13th largest U.S. import from China. Table 11. U.S. Imports of Prefabricated Buildings, Sanitary, Plumbing, Heating and Lighting Fixtures and Fittings (SITC 81) from Selected Countries and Country Groups, 1990, 2001-2005

1990 China Mexico Canada EU15 Taiwan ASEAN Hong Kong Japan Korea Rest of World World

(millions of dollars) 2001 2002 2003 2004 2005 94 2,383 2,962 3,199 3,697 117 903 961 1,036 1,132 80 572 598 617 693 205 329 319 356 428 495 156 152 151 154 27 116 106 115 121 47 70 77 80 73 28 59 36 41 49 61 32 36 42 37 78 275 319 362 422 1,232 4,895 5,566 5,999 6,806

4,146 1,300 762 497 142 137 59 52 37 464 7,596


Furniture In U.S. imports of furniture and related parts, China has become a dominant supplier. The PRC accounted for over 43% of U.S. furniture imports in 2005. U.S. imports of furniture from China now exceed the combined U.S. imports from Canada and Mexico, which were the leading foreign suppliers of furniture until the late 1990s. In 2004, the Bush Administration imposed anti-dumping penalties on approximately 500 furniture manufacturers in China.


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Source: U.S. Department of Commerce. Figure 15. U.S. Imports of Furniture and Parts (SITC 82) by Country and Group, 19902005

Table 12. U.S. Imports of Furniture and Parts (SITC 82) from Selected Countries and Country Groups, 1990, 2001-2005 1990 China Canada Mexico ASEAN EU15 Taiwan Japan Korea Hong Kong Rest of World World

(millions of dollars) 2001 2002 2003 2004 2005 6,954 8,742 10,905 145 5,017 4,423 4,551 5,007 1,209 4,411 3,824 4,275 4,316 578 3,212 1,753 1,886 2,303 331 1,492 2,321 2,489 2,491 1,174 2,309 765 794 748 753 1,009 141 107 135 181 162 75 75 69 68 67 98 90 109 97 29 1,219 1,289 1,557 299 1,081 5,003 18,601 21,560 24,293 27,678

13,179 5,126 4,297 2,800 2,371 716 210 111 82 1,691 30,583


Travel Goods and Handbags China has become the principal supplier of imported travel goods, handbags, and similar items, accounting for nearly 75% of U.S. imports of such merchandise


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in 2005. The EU has become an important supplier while China appears to have taken market shares from South Korea, Taiwan, and, more recently, ASEAN. This U.S. import category is ranked only 42st in total customs value.

Source: U.S. Department of Commerce. Figure 16. Imports of Travel Goods, Handbags, and Similar Products (SITC 83) by Country and Group, 1990-2005

Table 13. U.S. Imports of Travel Goods, Handbags, (SITC 83) from Selected Countries and Country Groups, 1990, 2001-2005

1990 China EU15 ASEAN Hong Kong Mexico Canada Taiwan Korea Japan Rest of World World

(millions of dollars) 2001 2002 2003 2004 2005 4,504 692 2,211 2,741 3,136 3,936 715 790 270 463 476 602 340 275 114 836 538 372 95 92 50 46 52 85 63 54 46 104 87 69 35 36 17 39 35 37 47 32 406 129 52 79 31 21 446 106 56 39 12 12 9 7 7 8 248 262 121 384 292 233 6,078 2,171 4,325 4,336 4,660 5,522



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Apparel and Clothing U.S. imports of apparel and clothing accessories from China have been rising, reaching 26% of U.S. imports in 2005. According to some estimates, more than 80% of Chinese apparel exports are produced by joint ventures, many of them involving East Asian investment.118 Global quotas on imported textiles and apparel expired on January 1, 2005, pursuant to the Multi-Fiber Agreement, resulting in a surge in U.S. garment imports from China, which increased by 46% in 2005. Other nations with large gains in the U.S. apparel market were India (up 33%), Indonesia (20%) Bangladesh (20%), and Cambodia (20%). Although wages for low skill labor in China reportedly are rising relative to other developing countries, China’s clothing manufacturers retain competitive advantages such as high labor productivity, “vertical integration” — the ability to produce all manufacturing inputs domestically — and developed infrastructure. In November 2005, the United States and the PRC signed a three-year agreement on textiles trade which imposes quotas on 21 types of Chinese textiles and clothing but which allows for a progressive increase in U.S. imports of apparel products from China through 2008.

Source: U.S. Department of Commerce. Figure 17. U.S. Imports of Apparel and Clothing Accessories (SITC 84) by Country and Group, 1990-2005 118

Jiang Jingjin, “China Not the Only Beneficiary,” China Daily (China Business Weekly), April 5, 2004.


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Table 14. U.S. Imports of Apparel and Clothing Accessories (SITC 84) from Selected Countries and Country Groups, 1990, 2001-2005 1990 China ASEAN Mexico Hong Kong EU15 Canada Korea Taiwan Japan Rest of World World

(millions of dollars) 2001 2002 2003 2004 2005 9,538 11,341 13,567 3,422 8,852 3,404 9,581 10,020 11,773 12,157 7,731 7,199 6,943 709 8,127 3,928 3,760 3,919 3,974 4,282 2,473 2,564 2,586 1,790 2,584 1,799 1,740 1,692 247 1,764 2,206 1,925 1,936 3,244 2,354 1,664 1,690 1,626 2,475 1,907 205 252 325 158 170 5,891 24,168 24,150 25,907 27,438 25,314 63,789 63,714 68,060 72,189

19,888 13,043 6,321 3,553 2,444 1,468 1,253 1,203 121 26,983 76,277


Source: U.S. Department of Commerce. Figure 18. U.S. Imports of Footwear (SITC 85) by Country and Group, 1990-2005

Footwear U.S. imports of footwear from China surged during the 1990s. From $1.5 billion in 1990, they rose to over $10 billion in 2002 or two-thirds of all such


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imports. China has largely replaced South Korea and Taiwan as the main source of Asian-produced footwear in the United States. Other large suppliers are Italy, Brazil, and Vietnam. Table 15. U.S. Imports of Footwear (SITC 85) from Selected Countries and Country Groups, 1990, 2001-2005

1990 China EU15 ASEAN Mexico Canada Taiwan Hong Kong Korea Japan Rest of World World

(millions of dollars) 2001 2002 2003 2004 2005 12,654 1,475 9,766 10,241 10,546 11,347 1,826 1,763 1,722 1,558 1,523 1,950 1,237 1,184 1,259 1,525 579 1,185 278 275 242 247 165 311 67 64 76 93 53 78 73 73 80 69 1,528 75 67 60 86 52 109 81 65 50 51 45 2,558 103 2 2 2 3 5 2 1,523 1,542 1,632 1,588 1,543 1,698 17,834 9,538 15,249 15,379 15,559 16,497


Source: U.S. Department of Commerce. Figure 19. U.S. Imports of Professional, Scientific, and Controlling Instruments (SITC 87) by Country and Group, 1990-2005

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Professional, Scientific, and Controlling Instruments China is a minor supplier of U.S. imports of professional, scientific and controlling instruments, supplying 8% of U.S. imports in this category in 2005. Over two-thirds of such imports originate in the European Union, Mexico, and Japan. Table 16. U.S. Imports of Professional, Scientific and Controlling Instruments and Apparatus (SITC 87) from Selected Countries and Country Groups, 1990, 2001-2005

EU15 Mexico Japan China Canada ASEAN Taiwan Korea Hong Kong Rest of World World

(millions of dollars) 1990 2001 2002 2003 2004 2005 2,310 6,887 6,543 7,744 10,225 10,802 513 3,895 4,436 5,090 5,082 5,371 1,494 3,561 2,902 3,177 4,016 3,887 74 1,172 1,301 1,660 2,176 2,483 527 1,793 1,575 1,406 1,611 1,833 152 1,027 1,037 1,139 1,448 1,571 176 372 393 450 458 472 89 152 156 153 177 230 82 55 67 70 67 79 604 2,287 2,400 2,675 3,101 3,433 6,021 21,201 20,810 23,564 28,361 30,161


Photographic and Optical Equipment and Timepieces China is a rising supplier of photographic apparatus, equipment and supplies and optical goods as well as watches and clocks. In 2005, China accounted for 17.5% of U.S. imports of such products. Japan and the European Union still dominate U.S. imports. By country, the top three suppliers of such imports for the United States are Japan, China, and Switzerland.


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Source: U.S. Department of Commerce. Figure 20. U.S. Imports of Photographic Equipment, Optical Goods, Watches and Clocks (SITC 88) by Country and Group, 1990-2005

Table 17. U.S. Imports of Photographic Apparatus, Equipment and Supplies and Optical Goods; Watches and Clocks (SITC 88) from Selected Countries and Country Groups, 1990, 2001-2005 1990 Japan EU15 China ASEAN Mexico Canada Taiwan Hong Kong Korea Rest of World World

(millions of dollars) 2001 2002 2003 2004 2005 2,668 3,848 3,309 3,138 3,140 1,619 2,439 2,535 2,612 2,716 191 1,908 1,842 2,001 2,239 199 650 664 587 614 128 648 634 555 665 180 545 414 461 428 334 282 288 280 265 526 236 200 164 182 127 168 150 134 124 574 1,348 1,353 1,510 1,797 6,546 12,072 11,389 11,442 12,170


3,082 2,807 2,153 646 494 469 258 178 127 2,072 12,286


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FOREIGN DIRECT INVESTMENT IN CHINA Fueling China’s export boom is an unprecedented infusion of foreign capital in the manufacturing sector.119 Foreign direct investment (FDI) is directed toward investments in companies in which the foreign investor has a controlling interest. It is primarily for physical plant and equipment and for the costs of establishing enterprises in China. It is not for portfolio investment on China’s stock exchanges. In 2002, China overtook the United States as the world’s largest recipient of foreign direct investment. In 2005, China remained in that position, despite a slight decrease from a year earlier, with $60 billion in utilized FDI. The United States is one of the largest sources of utilized FDI in China, investing $3.1 billion in 2005. (See Table 18.) China relies heavily upon investment from Hong Kong and other East Asian countries and regions. A significant amount of FDI from Hong Kong comes from Taiwan or from mainland Chinese companies via their subsidiaries in Hong Kong.120 Annual or utilized FDI from Japan and South Korea surpassed that of the United States in 2003. In 2004, South Korea surpassed Japan to be the third largest source of FDI in China. The United States remains the second largest source of cumulative FDI after Hong Kong. China’s WTO commitments include allowing more foreign investment in sectors such as telecommunications, energy, banking, and insurance. Table 18. China’s Utilized Foreign Direct Investment Inflows, Top Foreign Investors, 2000-2005 (billions of dollars) Country or Region Hong Kong Virgin Islands121 Japan South Korea United States Singapore

119

2001 16.7 5.0 4.3 2.1 4.4 2.1

2002 17.8 6.1 4.2 2.7 5.4 2.3

2003 17.7 5.7 5.0 4.5 4.2 2.0

2004 18.9 6.7 5.4 6.2 3.9 2

2005 17.1 9.0 6.5 5.2 3.1 2.2

For further discussion of China’s economy and foreign investment, see CRS Report RL33534, China’s Economic Conditions, by Wayne M. Morrison. 120 Mainland subsidiaries in Hong Kong and Macao can take advantage of investment incentives for foreign companies on the PRC mainland. 121 Many foreign firms, including U.S. companies, are registered in the Virgin Islands, Cayman Islands, and Western Samoa for tax purposes.


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(billions of dollars) Country or Region Taiwan Germany All Sources

2001 2.9 1.2 46.9

2002 3.9 0.9 52.7

2003 3.4 0.8 53.5

2004 3.1 1 64

2005 2.1 1.5 60.3

Source: U.S. & Foreign Commercial Service and U.S. Department of State, “Doing Business in China: A Country Commercial Guide for U.S. Companies,” 2006.

APPENDIX Table A1. China’s Merchandise Trade with the World, 1984-2005 (millions of dollars) China’s Trade with the World World Trade with China (Chinese data) (Partner Country Data)

Year 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

China China China Exports Imports Balance 24,824 25,953 -1,129 27,329 42,534 -15,205 31,367 43,247 -11,880 39,464 43,222 -3,758 47,663 55,352 -7,689 52,916 59,131 -6,215 62,876 53,915 8,961 71,940 63,855 8,085 85,492 81,843 3,649 91,611 103,552 -11,941 120,822 115,629 5,193 148,892 132,063 16,829 151,093 138,949 12,144 182,917 142,163 40,754 183,744 140,385 43,359 194,932 165,717 29,215 249,212 225,097 24,115 266,200 243,600 22,600 325,642 295,302 30,339

World World Exports Imports 24,640 26,904 38,355 30,867 36,152 35,310 39,250 46,654 51,794 59,748 51,666 72,810 49,036 88,692 61,732 112,372 81,996 136,853 108,406 156,896 120,634 191,663 145,897 233,614 156,200 254,440 165,230 286,540 152,890 289,620 162,650 322,080 212,060 398,060 221,450 413,280 270,930 483,610

World Balance -2,264 7,488 842 -7,404 -7,954 -21,144 -39,656 -50,640 -54,857 -48,490 -71,029 -87,717 -98,240 -121,310 -136,730 -159,430 -186,000 -191,830 -212,680

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Congressional Research Service Table A1. Continued (millions of dollars) China’s Trade with the World World Trade with China (Chinese data) (Partner Country Data)

Year 2003 2004 2005

China China China Exports Imports Balance 438,472 413,095 25,377 593,647 560,811 32,831 762,326 660,221 102,105

World World Exports Imports 422,590 601,920 527,370 794,480 647,690 989,880

World Balance -179,330 -267,110 -342,190

Note: Summation of data reported by 109 of China’s trading partner countries in 1983 growing to 156 countries reporting in 2005. Sources: Chinese data: PRC General Administration of Customs and Global Trade Atlas. World Data: International Monetary Fund, Direction of Trade Statistics Yearbook and Direction of Trade Statistics Quarterly.

Table A2. U.S. Merchandise Trade with China and China’s Merchandise Trade with the United States, 1984-2005 (millions of dollars) U.S. Trade with China China’s Trade with U.S. (U.S. data) (Chinese data)

Year 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995

U.S. U.S. U.S. China China China Exports Imports Balance Exports Imports Balance 3,004 3,381 -377 2,313 3,837 -1,524 3,856 4,224 -368 2,336 5,199 -2,863 3,106 5,241 -2,135 2,633 4,718 -2,085 3,497 6,910 -3,413 3,030 4,836 -1,806 5,017 9,261 -4,244 3,399 6,633 -3,234 5,807 12,901 -7,094 4,414 7,864 -3,450 4,807 16,296 -11,489 5,314 6,591 -1,277 6,287 20,305 -14,018 6,198 8,010 -1,812 7,470 27,413 -19,943 8,599 8,903 -304 8,767 31,183 -22,416 16,976 10,633 6,343 9,287 41,362 -32,075 21,421 13,977 7,444 11,749 48,521 -36,772 24,744 16,123 8,621


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(millions of dollars) U.S. Trade with China China’s Trade with U.S. (U.S. data) (Chinese data)

Year 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

U.S. U.S. U.S. China China China Exports Imports Balance Exports Imports Balance 11,978 54,409 -42,431 26,731 16,179 10,552 12,805 65,832 -53,027 32,744 16,290 16,454 14,258 75,109 -60,851 38,001 16,997 21,004 13,118 81,786 -68,668 41,946 19,480 22,466 16,253 100,063 -83,810 52,104 22,363 29,741 19,234 102,280 -83,046 54,300 26,200 28,100 22,053 125,167 -103,115 69,959 27,227 42,731 26,806 151,620 -123,960 92,510 33,882 58,628 34,721 196,699 -161,978 124,973 44,652 80,321 41,836 243,462 -201,626 162,938 48,734 114,204

Sources: U.S. data from U.S. Department of Commerce. Chinese data from PRC General Administration of Customs and Global Trade Atlas.

Table A3. Japan’s Merchandise Trade with China and China’s Merchandise Trade with Japan, 1984-2005 (millions of dollars) Japan’s Trade with China China’s Trade with Japan (Japanese Data) (Chinese Data) Year 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997

Japan Japan Japan China China China Exports Imports Balance Exports Imports Balance 7,199 5,943 1,256 5,155 8,057 12,590 6,534 6,056 6,091 15,178 9,936 5,727 4,209 5,079 12,463 8,337 7,478 859 6,392 10,087 9,486 9,861 -375 8,046 11,062 8,477 11,083 -2,606 8,395 10,534 6,145 12,057 -5,912 9,210 7,656 8,605 14,248 -5,643 10,252 10,032 11,967 16,972 -5,005 11,699 13,686 17,353 20,651 -3,298 15,782 23,303 18,687 27,569 -8,882 21,490 26,319 21,934 35,922 -13,988 28,466 29,007 21,827 40,405 -18,578 30,888 29,190 21,692 41,827 -20,135 31,820 28,990

-2,902 -9,087 -7,384 -3,695 -3,016 -2,139 1,554 220 -1,987 -7,521 -4,829 -541 1,698 2,830


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Table A3. Continued (millions of dollars) Japan’s Trade with China China’s Trade with Japan (Japanese Data) (Chinese Data) Year Japan Japan Japan China China China Exports Imports Balance Exports Imports Balance 20,182 37,079 -16,897 29,718 28,307 23,450 43,070 -19,620 32,400 33,768 30,440 55,340 -24,900 41,611 41,520 30,941 57,795 -26,558 45,078 42,810 40,001 61,882 -21,881 48,483 53,489 57,474 75,579 -18,105 59,453 74,204 73,971 94,446 -20,475 73,536 94,191 79,972 108,515 -28,543 84,097 100,467

1998 1999 2000 2001 2002 2003 2004 2005

1,411 -1,368 90 2,267 -5,006 -14,751 -20,655 -16,370

Sources: IMF, Direction of Trade Statistics Quarterly; Global Trade Atlas; PRC, General Administration of Administration of Customs.

Table A4. European Merchandise Trade with China and China’s Merchandise Trade with the European Union, 1984-2005 (millions of dollars) EU-15 Trade with China China’s Trade with the EU-15 (EU data) (Chinese Data) Year EU Exports 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998

EU EU China China China Imports Balance Exports Imports Balance 290 2,232 3,323 -1,091 2,929 2,639 2,513 2,283 6,157 -3,874 5,484 2,971 2,297 4,017 7,757 -3,740 6,403 4,106 485 3,916 7,274 -3,358 6,430 5,945 -947 4,746 8,176 -3,430 6,772 7,719 -2,517 5,114 9,785 -4,671 7,360 9,877 -5,916 6,275 9,147 -2,872 7,373 13,289 -10,441 7,127 9,297 -2,170 7,719 18,160 -11,391 8,004 10,863 -2,859 9,604 20,995 -9,429 12,258 15,739 -3,481 14,301 23,730 -11,398 15,418 18,604 -3,186 16,246 27,644 -13,006 19,258 21,313 -2,055 19,327 32,333 -17,053 19,868 19,883 -15 18,387 35,440 -24,118 23,865 19,205 4,660 18,054 42,172 -27,707 28,148 20,715 7,433 19,298 47,005


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(millions of dollars) EU-15 Trade with China China’s Trade with the EU-15 (EU data) (Chinese Data) Year EU Exports 1999 2000 2001 2002 2003 2004 2005

EU EU China China China Imports Balance Exports Imports Balance -32,247 30,207 25,463 4,744 20,326 52,573 -40,958 38,193 30,845 7,348 23,063 64,022 -41,025 40,904 35,723 5,181 26,620 67,634 -45,227 48,184 38,552 9,632 32,208 77,495 -64,345 72,457 53,112 19,345 44,217 108,562 -89,338 99,843 68,011 31,832 57,773 147,111 -121,840 134,872 71,694 63,178 61,894 183,734

Note: From 1980-88, data are for the 12 nations of the European Economic Community and after 1988 for the 15 nations of the EU (addition of Austria, Finland, and Sweden). Sources: IMF. Direction of Trade Statistics Yearbook and Direction of Trade Statistics Quarterly; Global Trade Atlas; PRC. General Administration of Customs.

Table A5. Major Country Merchandise Exports to China, Imports from China, and Trade Balances with China, 2004 and 2005 (billions of dollars) Trading Partner Data Partner 2004 2005 2004 Exp Imp Bal Exp Imp Bal Exp Imp U.S. 34.7 196.6 -161.9 41.8 243.4 -201.6 44.6 Japan 73.9 94.4 -20.5 79.9 108.5 -28.5 94.2 EU-15 57.7 146.7 -89.0 61.9 183.7 -121.8 68.0 Hong Kong 114.2 118.0 -3.8 130.3 135.1 -4.8 11.8 Taiwan 44.9 16.7 28.2 51.8 19.9 31.9 64.7 S. Korea 54.9 29.2 25.7 69.8 38.6 31.2 62.0 Germany 26.0 38.4 -12.4 26.4 49.4 -23.0 30.0 Singapore 15.4 16.2 -0.8 19.7 20.5 -0.8 14.0 U.K. 4.3 19.1 -14.8 5.1 23.9 -18.8 4.7 France 6.7 14.5 -7.8 8.0 17.9 -9.9 7.6

Chinese Data Bal 124.9 73.5 99.8 101.0 13.5 27.8 23.7 12.6 14.9 9.9

2005 Imp Bal 48.7 162.9 -114.2 100.4 84.1 16.3 71.7 134.8 -63.1 12.2 124.5 -112.3 74.6 16.7 57.9 76.8 35.1 41.7 30.6 32.5 -1.9 16.5 16.7 -0.2 5.5 18.9 -13.4 9.0 11.6 -2.6

Exp -80.3 20.7 -31.8 -89.2 51.2 34.2 6.3 1.4 -10.2 -2.3

Sources: IMF. Direction of Trade Statistics Yearbook and Direction of Trade Statistics Quarterly; Global Trade Atlas; Hong Kong Trade Development Council; Ministry of Economic Affairs, Board of Foreign Trade (Taiwan).

Table A6. U.S. Merchandise Trade Balances with Selected Asian Developing Nations, 1984-2005 (millions of dollars) Year China Indonesia S. Korea Malaysia Philippines Taiwan 1984 -377 -4,674 -4,188 -9983 -913 1985 -373 -4,152 -4,992 -936 -959 1986 -2,135 -2,757 -7,588 -807 -805 1987 -3,422 -2,955 -10,326 -1,159 -898 1988 -4,237 -2,438 -10,578 -1,715 -1,069 1989 -7,094 -2,618 -7,115 -2,052 -1,102 1990 -11,488 -1,785 -4,888 -2,071 -1,151 1991 -14,018 -1,675 -2,224 -2,446 -1,439 1992 -19,943 -1,927 -2,732 -4,144 -1,870 1993 -24,927 -3,117 -3,003 -4,858 -1,646 1994 -32,076 -4,209 -2,346 -7,454 -2,137 1995 -36,772 -4,599 523 -9,162 -2,070 1996 -42,431 -4,778 3,286 -9,809 -2,372 1997 -53,026 -5,222 1,269 -7,695 -3,370 1998 -56,927 -7,042 -7,456 -10,043 -5,211 1999 -68,668 -7,575 -8,308 -12,349 -5,153 2000 -83,810 -7,839 -12,398 -14,573 -5,147 2001 -83,045 -7,605 -12,988 -12,956 -3,666 2002 -103,115 -7,062 -12,979 -13,661 -3,715 2003 -123,960 -6,999 -12,864 -14,517 -2,068 2004 -161,977 -8,142 -19,829 -17,288 -2,072 2005 -201,625 -8,971 -16,109 -23,252 -2,355 Source: U.S. Department of Commerce, International Trade Commission.

-11,266 -13,295 -16,069 -19,221 -14,314 -14,305 -12,347 -11,038 -10,601 -10,050 -10,864 -10,863 -12,610 -13,331 -14,960 -16,077 -16,134 -15,239 -13,805 -14,111 -12,866 -12,788

Thailand -381 -804 -1,018 -904 -1,739 -2,343 -2,597 -2,693 -3,944 -5,214 -5,938 -5,452 -4,587 -5,699 -8,198 -9,340 -9,747 -8,733 -9,939 -9,338 -11,214 -12,569

Chapter 4

CHINA - U.S. TRADE ISSUES

*

Congressional Research Service SUMMARY U.S.-China economic ties have expanded substantially over the past several years. Total U.S.-China trade, which totaled only $5 billion in 1980, rose to $387 billion in 2007. China overtook Japan to become the third largest U.S. export market, and overtook Canada to become the largest source of U.S. imports. With a huge population and a rapidly expanding economy, China is a potentially huge market for U.S. exporters. However, U.S.-China economic relations have become strained over a number of issues, including large and growing U.S. trade deficits with China (which hit $256 billion in 2007), China’s failure to fully implement its World Trade Organization (WTO) commitments (especially in regards to protection of intellectual property rights), its refusal to adopt a floating currency system, its use of industrial policies and other practices deemed unfair and/or harmful to various U.S. economic sectors, and failure to ensure that its exports to the United States meet U.S. health and safety standards. The Bush Administration has come under increasing pressure from Congress to take a more aggressive stance against various Chinese economic and trade practices. In response, it filed a number of trade dispute resolution cases against China in the WTO, including China’s failure to protect IPR and afford market *

This is an edited, excerpted and augmented edition of Congressional Research Report RL33536 updated March 7, 2008.

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access for IPR-related products, discriminatory regulations on imported auto parts, and import and export subsidies to various industries in China. In addition, the Administration reversed a long-standing policy that countervailing cases (dealing with government subsidies) could not be brought against non-market economies (such as China). In December 2006, the Administration began a “Strategic Economic Dialogue” (SED) with China to discuss major long-term economic issues between the two countries; the latest SED talks were held in December 2007. In response to growing concerns in the United States over the health, safety, and quality of certain Chinese products, the Administration in 2007 concluded agreements with China on toys, food and feed, drugs and medical devices, and tires. Numerous bills have been introduced in Congress that would impact U.S.China economic relations. H.R. 321, H.R. 782, H.R. 1002, H.R. 2942, S. 364, S. 796, S. 1607, and S. 1677 seek to address China’s currency policy. H.R. 388 would prohibit U.S. imports of Chinese autos as long as Chinese tariffs on autos are higher than U.S. tariffs. H.R. 708, H.R. 1229, and S. 974 would apply U.S. countervailing laws to China. H.R. 1958 and S. 571 would terminate China’s permanent normal trade relations status. H.R. 275 would prohibit U.S. companies from aiding regimes that restrict Internet access. S. 1919 would limit the president’s discretion on Section 421 investigations on import surges from China. H.R. 3273 would expand U.S. export promotion programs to boost exports to China. Finally, numerous bills have been introduced to address concerns over unsafe imports (including from China). This report examines major U.S.-China trade issues and will be updated as events warrant. Economic and trade reforms begun in 1979 have helped transform China into one of the world’s fastest growing economies. China’s economic growth and trade liberalization, including comprehensive trade commitments made upon entering the World Trade Organization (WTO) in 2001, have led to a sharp expansion in U.S.-China economic ties. Yet, bilateral trade relations have grown increasingly strained in recent years over a number of issues, including a large and growing U.S. trade deficit with China (which hit $256 billion in 2007), China’s refusal to adopt a floating currency, and failure to fully implement many of its WTO obligations, especially in regards to IPR protection. Several Members have called on the Administration to take a tougher stance against China to induce it to eliminate economic policies deemed harmful to U.S. economic interests and/or are inconsistent with WTO rules. In addition, there has been growing concerns in the United States over the health and safety of certain food products (such as seafood and pet food) and consumer products (such as toys and tires)

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imported from China that have been found to be unsafe or defective, and some Members have called for measures to pressure China to ensure its exports are safe as well as to strengthen U.S. federal agencies in charge of enforcing health and safety standards. This report provides an overview of U.S.-China economic relations, surveys major trade disputes, and lists major legislation in the 110th that seeks to address these issues.

U.S. TRADE WITH CHINA1 U.S.-China trade rose rapidly after the two nations established diplomatic relations (January 1979), signed a bilateral trade agreement (July 1979), and provided mutual most-favored-nation (MFN) treatment beginning in 1980. In 1978 (before China’s reforms began), total U.S.-China trade (exports plus imports) was $1 billion; China ranked as the 32nd largest export market and the 57th largest source of U.S. imports. In 2007, bilateral trade hit $387 billion, making China the 2nd largest U.S. trading partner (after Canada). China overtook Japan to become the 3rd largest U.S. export market and also overtook Canada to become the largest source of U.S. imports. In recent years, China has been one of the fastest growing U.S. export markets and the importance of this market is expected to grow even further as living standards continue to improve and a sizable Chinese middle class emerges. The U.S. trade deficit with China has surged in recent years as imports from China have grown much faster than U.S. exports to China. That deficit rose from $30 billion in 1994 to $256 billion in 2007 (see Table 1).2 The U.S. trade deficit with China is significantly larger than that with any other U.S. trading partner. In 2007, it was more than twice as large as with OPEC, as well as the 27 countries that make up the European Union, and three times larger than the trade deficit with Japan (see Table 2). 1

For additional statistics on U.S.-China trade, see CRS Report RL31403, China’s Tradewith the United States and the World, by Thomas Lum and Dick K. Nanto. For general information on U.S.China ties, see CRS Report RL33877, China-U.S. Relations: Current Issues and Implications for U.S. Policy, by Kerry Dumbaugh. For more information on China’s economy, see CRS Report RL33534, China’s Economic Conditions, by Wayne M. Morrison. 2 The United States ran trade deficits with 105 countries in 2007. These totaled $896.2 billion; the trade deficit with China was equal to 28.6% of this amount. However, the United States ran trade surpluses with 127 countries, totaling $105.2 billion, and the total U.S. trade deficit was $791.0 billion. The U.S. trade deficit with China was equal to 32.4% of the total U.S. trade deficit.

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Congressional Research Service Table 1. U.S. Merchandise Trade with China: 1980-2007 ($ in billions) Year 1980 1985 1990 1995 2000 2001 2002 2003 2004 2005 2006 2007

U.S. Exports 3.8 3.9 4.8 11.7 16.3 19.2 22.1 28.4 34.7 41.8 55.2 65.2

U.S. Imports 1.1 3.9 15.2 45.6 100.1 102.3 125.2 152.4 196.7 243.5 287.8 321.5

U.S. Trade Balance 2.7 0 -10.4 -33.8 -83.8 -83.1 -103.1 -124.0 -162.0 -201.6 -232.5 -256.3

Source: USITC DataWeb.

Table 2. U.S. Merchandise Trade Balances with Major Trading Partners: 2007 ($ in billions) Country or Trading Group U.S. Trade Balance World -791.0 China -256.3 European Union (EU27) -107.4 Organization of Petroleum Exporting Countries (OPEC) -127.4 Japan -82.8 Canada Mexico Association of Southeast Asian Nations (ASEAN) Source: USITC DataWeb.

-64.7 -74.3 -50.6


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MAJOR U.S. EXPORTS TO CHINA U.S. merchandise exports to China in 2007 were $65.2 billion, up 18.1% over the previous year.3 China overtook Japan to become the 3rd largest export market in 2007. U.S. exports to China in 2007 accounted for 5.6% of total U.S. exports (compared to 3.9% in 2003). The top five U.S. exports to China in 2007 were aircraft and parts, semiconductors and electronic components, waste and scrap, oilseeds and grain, and resins and synthetic rubber and fibers (see Table 3). China is a significant market for U.S. agricultural products. It was the 4th largest destination for U.S. agricultural exports in 2007 at $8.3 billion. U.S. agricultural exports grew by 24% in 2007 over the previous year. Table 3. Major U.S. Exports to China: 2003-2007 ($ in billions and % change)

Source: U.S. International Trade Commission Database. Note: Commodities sorted by top five exports in 2007 using NAIC classification, fourdigit level.

Over the past few years, China has been one of the fastest growing U.S. export market among major U.S. trading partners, as can be seen in Table 4.4 U.S. exports to China rose by nearly 240% from 2001 to 2007, which was significantly higher than that of any other top 10 trading partner. 3

The United States also exports a significant level of private services to China; these totaled $9.1 billion in 2005. 4 However the growth in U.S. exports to China in 2007 (at 18.1%) was much slower than in 2006 (up 32% over 2005 levels).

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Congressional Research Service Table 4. U.S. Merchandise Exports to Major Trading Partners in 2001 and 2007 ($ in billions and % change)

Note: Ranked by top 10 U.S. export markets in 2007. Source: USITC DataWeb

Many trade analysts argue that China could prove to be a much more significant market for U.S. exports in the future. China is one of the world’s fastest-growing economies, and rapid economic growth is likely to continue in the near future, provided that economic reforms are continued. China’s goal of modernizing its infrastructure and upgrading its industries is predicted to generate substantial demand for foreign goods and services. Finally, economic growth has substantially improved the purchasing power of Chinese citizens, especially those living in urban areas along the east coast of China. China’s growing economy and large population make it a potentially enormous market. To illustrate: •

•

China currently has the world’s largest mobile phone network, and one of the fastest-growing markets, with an estimated 600 million cellular phone users (as of June 2007), compared to 87 million users in 2000. Boeing Corporation predicts that China will be the largest market for commercial air travel outside the U.S. for the next 20 years (2006-2026);


•

•

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during this period, China will buy 3,400 aircraft valued at $340 billion. By 2026, China’s domestic market for air travel is expected to become larger than today’s intra-North American market.5 On April 11, 2006, Boeing announced it had signed a general purchase agreement with China for 80 Boeing 737s. On September 6, 2007, China announced it would buy 55 Boeing aircraft valued at $3.8 billion. In 2002, China replaced Japan as the world’s second-largest PC market. China also became the world’s second-largest Internet user (after the United States). The number of Chinese internet users rose from 111 million at the end of 2005, to 137 million in 2006, to 210 million users at the end of 2007.6 The Chinese government projects that by the year 2020, there will be 140 million cars in China (seven times the current level), and that the number of cars sold annually will rise from 7.2 million units (2006) to 20.7 million units.7 According to some estimates, China is now the world’s second largest market for new cars. General Motors (GM) and Ford reportedly sold over one million (up 19% over 2006 levels) and 216 thousand cars (up 30%), respectively in China in 2007. According to the International Herald Tribune, GM expects invest $5 billion in China over the next five years to expand production facilities.8

However, some U.S. trade analysts contend that China continues to pursue industrial policies aimed at promoting the development of industries that have been deemed by the government as critical for Chinese future economic development. They claim such policies seek to restrict imports of finished products, thus forcing foreign firms to invest in China to gain access to the domestic market. They note a significant level of U.S. exports to China are raw materials, parts, and components used to produce finished goods for export.

5

Boeing, Press Release, September 18, 2007. People’s Daily Online, “210 million Internet users in China,” January 21, 2008. 7 China Daily, September 9, 2004. 8 International Herald Tribune, “GM plans $5 billion in China investment,” December 6, 2007. For additional information on China’s auto industry, see CRS Report RL33317, China’s Impact on the U.S. Automotive Industry, by Stephen Cooney. 6

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MAJOR U.S. IMPORTS FROM CHINA China in 2007 became, for the first time, the largest source of U.S. imports. In 2007, imports from China totaled $321.5 billion, accounting for 16.5% of total U.S. imports in 2007 (up from 6.5% in 1996). U.S. imports from China rose by 11.7% in 2007 over the previous year (compared with 18.2% in 2006). The importance (ranking) of China as a source of U.S. imports has risen dramatically, from 8th largest in 1990, to 4th in 2000, to 2nd in 2004-2006, to first in 2007. The top five U.S. imports from China in 2007 were computers and parts, miscellaneous manufactured articles (such as toys, games, etc.), communications equipment, apparel, and audio and video equipment (see Table 5). Table 5. Top Five U.S. Imports from China: 2003-2007 ($ in billions and % change)

Source: U.S. International Trade Commission Trade Data Web. Note: Commodities sorted by top five imports in 2007 using NAIC classification, fourdigit level.

Throughout the 1980s and 1990s, nearly all of U.S. imports from China were low-value, labor-intensive products such as toys and games, consumer electronic products, footwear, and textiles and apparel. However, over the past few years, an increasing proportion of U.S. imports from China has comprised of more technologically advanced products, such as computers. According to the U.S. Census Bureau, in 2007, U.S. imports of advanced technology products from China totaled $72.7 billion (27.4% of total U.S. imports from China), compared


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with $29.3 billion in 2003 (19.2% of total U.S. imports from China).9 In addition, imports of advanced technology products accounted for 26.9% of total U.S. imports of such products in 2007, compared with 14.1% in 2003, indicating that U.S. dependency on China for advanced technology products is rapidly increasing. Table 6. Major Foreign Suppliers of U.S. Computer Equipment Imports: 2000-2007 ($ in billions and % change)

Source: U.S. International Trade Commission Trade Data Web. Note: Ranked according to top six suppliers in 2007.

Many analysts contend that the sharp increase in U.S. imports from China is largely the result of movement in production facilities from other (primarily) Asian countries to China.10 That is, various products that used to be made in Japan, Taiwan, Hong Kong, etc., and then exported to the United States are now being made in China (in many cases, by foreign firms in China) and exported to the United States. An illustration of this shift can be seen in Table 6 on U.S. imports of computer equipment and parts from 2002-2007. In 2000, Japan was the largest foreign supplier of U.S. computer equipment (with a 19.6% share of total shipments), while China ranked 4th (with a 12.1% share). In just seven years, Japan’s ranking fell to 4th, the value of its shipments dropped by over half, and its share of shipments declined to 7.0% (2007). China was by far the largest foreign supplier of computer equipment in 2007 with a 51.5% share of total U.S. imports. While U.S. imports of computer equipment from China rose by 436% over the past seven years, the total value of U.S. imports from the world of these 9

U.S. Census Bureau, Foreign Trade Division. Chinese data indicate that the share of China’s exports produced by foreign-invested enterprises (FIEs) in China rose from 1.9% in 1986 to 57% in 2007. 10

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commodities rose by only 26%. Many analysts contend that a large share of the increase in Chinese computer production has come from foreign computer companies that have moved manufacturing facilities China. China is becoming a major supplier of U.S. agricultural products. It was the 3rd largest source of U.S. agricultural imports in 2007 (compared with 5th largest in 2006), at $3.3 billion.11 U.S. agricultural imports from China rose by 23% in 2007 and by 133% from 2003-2007. Major agricultural imports from China include fish, vegetables and fruit, tea and spices, feeding stuff for animals, and sugar products.

MAJOR U.S. - CHINA TRADE ISSUES Although China’s economic reforms and rapid economic growth have expanded U.S.-China commercial relations in recent years, tensions have arisen over a wide variety of issues, including the growth and size of the U.S. trade deficit with China (which many Members contend is an indicator that the trade relationship is unfair), concerns over unsafe Chinese food and consumer products, China’s currency policy (which many Members blame for the size of the U.S. trade deficit with China and the loss of manufacturing jobs in the United States), China’s mixed record on implementing its obligations in the WTO, failure to provide adequate protection of U.S. intellectual property rights (IPR), and Chinese industrial policies used to promote and protect domestic industries. Several bills have been introduced to respond to several of these issues (see section on legislation).

Health and Safety Concerns over Certain Imports from China12 Reports throughout 2007 of tainted or unsafe food and consumer products (including seafood, pet food, toys, and tires) from China raised concerns in the United States over the health, safety, and quality of imports from China. Some analysts contend that China maintains a poor regulatory framework for enforcing its health and safety regulations and standards, and that this is proving to be a growing problem for U.S. consumers. Many U.S. policymakers have raised 11 12

China ranked as the 4th largest export market for U.S. agricultural products at $8.3 billion. For additional information on this issue, see CRS Report RS22713, Health and Safety Concerns Over U.S. Imports of Chinese Products: An Overview, by Wayne M. Morrison


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concern over how to press China to improve enforcement of its health and safety standards of its exports as well as the ability of U.S. regulatory agencies to ensure the health and safety of imports from China (and other countries). In 2007 and early 2008, there were numerous recalls, warnings, and import restrictions involving Chinese products. To illustrate: The Food and Drug Administration (FDA) in March 2007 issued warnings and announced voluntary recalls on over 150 brands of pet foods (and products such as rice protein concentrate and wheat gluten used to manufacture pet food and animal feed) from China believed to have caused the sickness and deaths of numerous pets in the United States.13 In May 2007, the FDA issued warnings on certain toothpaste products (some of which were found to be counterfeit) found to originate in China that contained poisonous chemicals. In June 2007, the FDA announced import controls on all farm-raised catfish, basa, shrimp, dace (related to carp), and eel from China after antimicrobial agents, which are not approved in the United States for use in farm-raised aquatic animals, were found. The FDA ordered that such shipments will be detained until they are proven to be free of contaminants.14 On January 25, 2008, the FDA posted on its website a notice by Baxter Healthcare Corporation that it had temporarily halted the manufacture of its multiple-dose vials of heparin (a blood thinner) for injection because of recent reports of serious adverse events (including four deaths and 350 complications) associated with the use of this drug. Some analysts have speculated that an unlicensed drug company in China, which produces ingredients for the drug, may be the source of the problem.15 The National Highway Traffic Safety Administration (NHTSA) in June 2007 was informed by Foreign Tire Sales, Inc., an importer of foreign tires, that it suspected that up to 450,000 tires (later reduced to 255,000 tires) made in China may have a major safety defect (i.e., missing or insufficient gum strip inside the tire). The company was ordered by the NHTSA to issue a recall. The Chinese government and the manufacturer have maintained that the tires in question meet or exceed U.S. standards. The Consumer Product Safety Commission (CPSC) has issued alerts and announced voluntary recalls by U.S. companies on numerous products made in China. From January-December 2007, over four-fifths of CPSC recall notices have involved Chinese products. Over this period, roughly 17.6 million toy were 13

For a legal overview of FDA recalls, see CRS Report RL34167, The FDA’s Authority toRecall Products, by Vanessa K. Burrows. 14 In addition, FDA has refused shipments of a variety of Chinese food and drug products.See CRS Report RL34080, Food and Agricultural Imports from China, by Geoffrey S.Becker. 15 New York Times, China Didn’t Check Drug Supplier, Files Show, February 16, 2008.

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recalled because of excessive lead levels. Recalls were also issued on 9.5 million Chinese-made toys (because of the danger of loose magnets), 4.2 million “Aqua Dots” toys (because beads contain a chemical that can turn toxic if ingested) and 1 million toy ovens (due to potential finger entrapment and burn hazzards).16 China is the dominant supplier of toys to the United States, accounting for 89% of total U.S. imports (2007).

China’s Poor Regulatory System and Implications China is believed to have a rather weak health and safety regime for manufactured goods and agricultural products. Problems include:

• • • • • • • • • • • • • • 16

weak consumer protection laws and poorly enforced regulations, lack of inspections and ineffective penalties for code violators, underfunded and understaffed regulatory agencies and poor interagency cooperation, the proliferation of fake goods, the existence of numerous unlicensed producers, falsified export documents, extensive pollution,17 intense competition that often induces firms to cut corners, the relative absence of consumer protection advocacy groups, failure by Chinese companies to effectively monitor the quality of their suppliers’ products, restrictions on the media,18 and extensive government corruption and lack of accountability,

For a list of company recalls of Chinese products, see the CPSC website at[http://www.cpsc.gov/cpscpub/prerel/prerel.html]. In addition, several U.S. retailers haveannounced that they have halted sales of certain Chinese products, due to health and safetyconcerns, which do not appear on the CPSC website. 17 For example, many fish farmers in China are believed to feed various drugs to the fish tohelp keep them alive in polluted waters. See Washington Post, “Farmed in China’s FoulWaters, Imported Fish Treated with Drugs; Traditional Medicine, Banned Chemicals BothUsed,” July 6, 2007, p. A1. 18 China’s media often reports on health and safety problems, but rarely criticizes the centralgovernment for such problems.


•

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especially at the local government level.

Although China has criticized the United States for its recent actions against unsafe Chinese products,19 it has pledged to improve and strengthen food and drug safety supervision and standards, beef up inspections, require safety certificates before some products can be sold, and to crack down on government corruption. The United States and China reached a number of agreements in 2007 to address health and safety concerns:

•

• •

19

On September 11, 2007, the CPSC and its Chinese counterpart, the General Administration of Quality Supervision, Inspection and Quarantine (AQSIQ), signed a Joint Statement on enhancing consumer product safety. China pledged to implement a comprehensive plan to intensify efforts (such as increased inspections, efforts to educate Chinese manufacturers, bilateral technical personal exchanges and training, regular meetings to exchange information with U.S. officials, and the development of a product tracking system) to prevent exports of unsafe products to the United States, especially in regard to lead paint in toys. On September 12, 2007, the NHTSA signed a Memorandum of Cooperation with its Chinese counterpart on enhanced cooperation and communication on vehicles and automotive equipment safety. On December 11, 2007, the U.S. Health and Human Services (HHS) announced that it had signed two Memoranda of Agreements (MOA) with its Chinese counterparts; the first covering specific food and feed items that have been of concern to the United States, and the second covering drugs and medical devices. Both MOAs would require Chinese firms that export such products to the United States to register with the Chinese government and to obtain certification before they can export. Such firms would also be subject to annual inspections to ensure they meet U.S. standards. The MOAs also establish mechanisms for greater information sharing, increase access of production facilities by U.S. officials, and create working groups in order to boost cooperation.

In June 2007, China impounded U.S. shipments of apricots and orange pulp, claiming thatthey contained excessive bacteria. In July 2007, China had suspended some frozen chickenand pork products imported from the U.S., citing various health concerns. In August 2007,China rejected a shipment of U.S. pacemakers, due to quality concerns. Some analystscontend these have been retaliatory moves over U.S. recalls and detentions of Chineseproducts.

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Many Members of Congress (and some industry groups) have called for tighter scrutiny (such as increased inspections and certification requirements) of imported products, greater funding for U.S. regulatory agencies to inspect imports, and higher penalties against violators of U.S. health and safety laws.20 WTO rules allow countries to impose restrictions on imports for health and safety reasons as long as they are based on science, but forbid measures deemed to be discriminatory or protectionist in nature. Both the United States and China have accused each other of using health and safety concerns as an excuse to impose protectionist measures.

CHINA’S CURRENCY POLICY21 Between 1994 and July 2005, China pegged its currency, the renminbi (RMB) or yuan, to the U.S. dollar at about 8.28 yuan to the dollar. In order to maintain a target rate of exchange with the dollar, the government has maintained restrictions and controls over capital transactions and has made large-scale purchases of U.S. dollars (and dollar assets). Many U.S. policymakers and business representatives have charged that China’s currency is significantly undervalued vis-à-vis the U.S. dollar (with estimates ranging from 15% to 40%). They charge that China’s currency policy makes Chinese exports to the United States cheaper, and U.S. exports to China more expensive, than they would be if exchange rates were determined by market forces. They complain that this policy has particularly hurt several U.S. manufacturing sectors (such as textiles and apparel, furniture, plastics, machine tools, and steel), which are forced to compete against low-cost imports from 20

The primary bill addressing product safety that Congress is considering is H.R. 4040(Rush), which passed the House on December 19, 2007, and passed the Senate (as asubstitute amendment with several differences with the House version) on March 7, 2008.Although not identical, both bills would boost the CPSC’s funding and expand its authority,ban the sale of children’s products that contain more than trace levels of lead, and requirethird-party inspections and mandatory tracking labels for children’s products. For anoverview of legislative proposals to reform the CPSC, see CRS Report RL34399, ConsumerProduct Safety Commission Reform: S. 2045/S. 2663 and H.R. 4040, by Margaret MikyungLee; and CRS Report RS22821, Consumer Product Safety Commission: Current Issues, byBruce Mulock. For a listing of bills on food safety, see CRS Report RL34152, Food Safety:Selected Issues and Bills in the 110th Congress, by Geoffrey S. Becker. 21 For additional information on this issue, see CRS Report RS21625, China’s Currency: ASummary of the Economic Issues, by Wayne Morrison and Marc Labonte; and CRS ReportRL32165, China’s Exchange Rate: Economic Issues and Options for U.S. Trade Policy, byWayne Morrison and Marc Labonte.


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China, and that this has contributed to the growing U.S. trade deficit with China. They have called on the Bush Administration to pressure China either to significantly appreciate its currency or to let it float freely in international markets. Chinese officials argue that its currency policy is not meant to favor exports over imports, but instead to foster economic stability. They have expressed concern that abandoning its currency policy could cause an economic crisis in China and would especially hurt its export industries sectors at a time when painful economic reforms (such as closing down inefficient state-owned enterprises and restructuring the banking system) are being implemented. Chinese officials view economic stability as critical to sustaining political stability; they fear an appreciated currency could reduce jobs and lower wages in several sectors and thus cause worker unrest. U.S. critics of China’s currency policy contend that the low value of the yuan has forced other East Asian economies to keep the value of their currencies low vis-à-vis the U.S. dollar in order to compete with Chinese products. They further note that while China is still a developing country, it has been able to accumulate massive foreign exchange reserves (estimated to have reached nearly $1.5 trillion at the end of 2007) and thus has the resources to maintain the stability of its currency if it were fully convertible. They also argue that appreciating the yuan would greatly benefit China by lowering the cost of imports and by balancing economic growth to include greater domestic consumption. On the other hand, some analysts have indicated concern that pushing China to appreciate its currency could cause it to decrease purchases of U.S. Treasury securities, which might result in higher U.S. interest rates. China is the second largest foreign purchaser (after Japan) of U.S. Treasury securities, which totaled $406 billion at the end of 2007.

The Bush Administration’s Response President Bush has criticized China’s currency policy on a number of occasions, stating that exchange rates should be determined by market forces, and he has raised the issue during meetings with high level Chinese officials (including Chinese President Hu Jintao). Initially, the Bush Administration rejected calls from several Members to apply direct pressure on China to force it to abandon its currency peg. Instead, the Administration sought to encourage China to reform its financial system under the auspices of a joint technical cooperation program, agreed to on October 14, 2003.

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The Administration’s position on China’s currency policy appears to have toughened in April 2005, when (then) U.S. Treasury Secretary John Snow stated at a G-7 meeting that China was “ready now to adopt a more flexible exchange rate.” In its May 17, 2005 report on exchange rate policies, the Treasury Department stated that China’s currency peg policy “is a substantial distortion to world markets” and that “China is now ready to move to a more flexible exchange rate and should move now.” The report warned that the Treasury Department would closely monitor China’s progress over the next six months.

China Changes its Currency Policy On July 21, 2005, the Chinese government announced that the yuan’s exchange rate would become “adjustable, based on market supply and demand with reference to exchange rate movements of currencies in a basket,” (which include the U.S. dollar, the Japanese yen, the euro, the South Korean won, and a number of other currencies), and that the exchange rate of the yuan to the U.S. dollar would be immediately adjusted from 8.28 to 8.11, an appreciation of about 2.1%. Congressional reaction to China’s announcement was mixed — many welcomed the move, but some referred to it as merely a good first step and called on China to further appreciate the yuan. However, on July 26, 2005, China’s Central Bank stated it had no immediate plans for further revaluations and that reforms would be done in a “gradual” way. Section 3004 of the 1988 Omnibus Trade and Competitiveness Act (P.L. 100418) requires the Secretary of Treasury to issue a report every six months on international economic policy (including exchange rate policy) and to determine if any country is manipulating its currency in order to prevent an effective balance of payments adjustment or to gain an unfair competitive advantage in international trade. Since China reformed its currency in July 2005, Treasury has continued to press China to reform its currency, but has not cited it for currency manipulation. According to the Bank of China, from July 21, 2005, to February 29, 2008, the dollar-yuan exchange rate went from 8.11 to 7.12, an appreciation of 13.9%.22 Many members contend that China’s currency reforms and the appreciation of its currency have not moved fast enough. As a result, numerous bills have been introduced in Congress to respond to China’s currency policy (see section on legislation). 22

Source: Calculated from Bank of China data using the official middle rate.


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CHINA AND THE WORLD TRADE ORGANIZATION Negotiations for China’s accession to the General Agreement on Tariffs and Trade (GATT) and its successor organization, the WTO, began in 1986 and took over 15 years to complete. During the WTO negotiations, Chinese officials insisted that China was a developing country and should be allowed to enter under fairly lenient terms. The United States insisted that China could enter the WTO only if it substantially liberalized its trade regime. In the end, a compromise was reached that requires China to make immediate and extensive reductions in various trade and investment barriers, while allowing it to maintain some level of protection (or a transitionary period of protection) for certain sensitive sectors. China’s WTO membership was formally approved at the WTO Ministerial Conference in Doha, Qatar on November 10, 2001 (Taiwan’s WTO membership was approved the next day). On November 11, 2001, China notified the WTO that it had formally ratified the WTO agreements, and on December 11, 2001, it formally joined the WTO. Under the WTO accession agreement, China agreed to:

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Reduce the average tariff for industrial goods and agriculture products to 8.9% and 15%, respectively (with most cuts made by 2004 and all cuts completed by 2010). Limit subsidies for agricultural production to 8.5% of the value of farm output and eliminate export subsidies on agricultural exports. Within three years of accession, grant full trade and distribution rights to foreign enterprises (with some exceptions, such as for certain agricultural products, minerals, and fuels). Provide non-discriminatory treatment to all WTO members. Foreign firms in China will be treated no less favorably than Chinese firms for trade purposes. End discriminatory trade policies against foreign invested firms in China, such as domestic content rules and technology transfer requirements. Implement the WTO’s Trade-Related Aspects of Intellectual Property Rights (TRIPS) Agreement upon accession. That agreement establishes basic standards on IPR protection and rules for enforcement. Accept a 12-year safeguard mechanism (available to other WTO members as well) in cases where a surge in Chinese exports cause or threaten to cause market disruption to domestic producers.

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Fully open the banking system to foreign financial institutions withing five years (i.e., by the end of 2006). Joint ventures in insurance and telecommunication will be permitted (with various degrees of foreign ownership allowed).

WTO IMPLEMENTATION ISSUES China has made great strides in implementing key aspects of its WTO commitments. For example, its average overall tariff has dropped to from 15.6% in 2001 to 9.9% in 2006 and a number of non-tariff measures have been eliminated. However, there have been several areas where China’s implementation is considered to be incomplete. The USTR’s sixth annual China WTO compliance report (issued in December 2007) identified several areas of concern, including failure by the Chinese government to maintain an effective IPR enforcement regime (discussed below), industrial policies that attempt to promote Chinese firms (while discriminating against foreign firms), restrictions on trading and distribution rights (especially in regards to IPR products, such as movies, books, and music), discriminatory and unpredictable health and safety rules on imports (especially agricultural products), burdensome regulations and restrictions on services (including excessive capital requirements), and failure to provide adequate transparency of trade laws and regulations.23 The USTR’s 2007 China WTO report stated that China’s failure to comply with key areas of its WTO commitments largely stemmed in part from its incomplete transition to a market based economy. A significant part of the economy, including the banking system and state owned enterprises (SOEs), are controlled by the central government — remnants of the old command economy that existed before reforms began in 1979. Although China agreed to make SOEs operate according to free market principles when it joined the WTO, U.S. officials contend that SOEs are still being subsidized, especially through the banking system. In addition, China is attempting to promote the development of several industries (such as autos, steel, telecommunications, and high technology products) deemed by the government as important to China’s future economic development and has implemented policies to promote and protect them. When China joined the WTO, it agreed to provide a full description of all its subsidy programs, but to date has failed to fully do so. In addition, China agreed to make its state-owned enterprises operate according to market principles; yet 23

USTR, 2007 Report to Congress on China’s WTO Compliance, December 11, 2007.


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such firms continue to receive direction and subsidies. Some major issues of concern to the United States include the following:

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In December 2006, the Chinese government designated seven industries (military equipment, power generation and distribution, oil, telecommunications, coal, civil aviation, and shipping) as critical to the nation’s economic security and stated it must retain “absolute control” and limit foreign participation.24 On June 30, 2006, China announced a partial opening of its beef market (which had been completely closed to U.S. imports in 2003 due to concerns over mad cow disease). However, U.S. officials have expressed disappointment that China has failed to develop a science-based trading protocol for importing beef from the United States, which would enable the United States to resume beef trade with China. In July 2005, the Chinese government issued new guidelines on steel production, which reportedly includes provisions for the preferential use of domestically produced steel-manufacturing equipment and domestic technologies; extensive government involvement in determining the number, size, location, and production quantities of steel producers in China; technology transfer requirements on foreign investment, and restrictions on foreign majority ownership. On June 14, 2006, Assistant U.S. Trade Representative for China Tim Stratford stated that China’s steel guidelines were “troubling, because it attempts to dictate industry outcomes and involves the government in making decisions that should be left to the marketplace.25 “The U.S. steel industry has expressed growing fears that Chinese government policies have led to overinvestment and overcapacity in China’s domestic steel industry, which could lead it to flood world markets with cheap steel.26 Such concerns led the USTR to begin a Steel Dialogue with China (which first met in March 2006) to discuss issues of concern to the U.S. steel industry.

China Daily, “Nation Lists Sectors Critical to National Economy,” December 19, 2006. Statement of Timothy Stratford, Assistant U.S. Trade Representative for China Affairs,before the Congressional Steel Caucus, June 14, 2006. 26 China is now the world’s largest steel producer, accounting for 31% of the world’s steelproduction. Its steel production levels rose by 25% over the previous year. According toU.S. officials, China’s excess steel capacity in 2006 could be larger than total U.S. steelproduction. 25

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China’s Automotive Industrial Policy, issued by the government in May 2004 includes provisions discouraging the importation of auto parts and encouraging the use of domestic technology, while requiring new automobile and automobile engine plants to include substantial investment in research and development facilities. New auto parts regulations that went into effect in April 2005 discriminate against imported auto parts by assessing an additional charge on imported parts if they are incorporated into a vehicle that does not meet minimum levels of domestic content.27

U.S. WTO Cases against China To date, the United States has initiated five WTO dispute resolution cases against China, two of which have been resolved. Cases outstanding include:

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On March 3, 2008, the USTR requested WTO dispute resolution consultations with China regarding its discriminatory treatment of U.S. suppliers of financial information services in China. On April 10, 2007, the USTR filed two IPR-related cases against China: the first case charges that China has failed to comply with the TRIPS agreement (namely in terms of its enforcement of IPR laws) and the second case charges that China has failed to provide sufficient market access to IPR-related products, namely in terms of trading rights and distribution services (see below). On March 30, 2006, the USTR initiated a WTO case against China for its use of discriminatory regulations applied to imported auto parts (which often applies the high tariff rate on finished autos to certain auto parts), stating that the purpose of these rules was to discourage domestic producers from using imported parts and encouraging foreign firms to move production to China. On February 13, 2008, a WTO panel ruled that China’s discriminatory tariff policy was inconsistent with its WTO obligations.

China applies higher tariffs on imported auto parts when a specific combination of partsis used to produce cars in China, or if the value of these parts amounts to 60% or more ofthe cost of a car made in China. This policy increases tariffs on some auto parts from about10% to about 25% (which is the tariff China currently applies to imports of completedautos). Source: USTR 2007 Report to Congress on China’s WTO Compliance, p. 61.


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The two WTO cases that have been resolved include:

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On February 5, 2007, the USTR announced it had requested WTO dispute consultations with China over government regulations that give illegal (WTO-inconsistent) import and export subsidies to various industries in China (such as steel, wood, and paper) that distort trade and discriminate against imports.28 China’s WTO accession agreement required it to immediately eliminate such subsidies. On November 29, 2007, China formally agreed to eliminate the subsidies in question by January 1, 2008. On March 18, 2004, the USTR announced it had filed a WTO dispute resolution case against China over its discriminatory tax treatment of imported semiconductors. The United States claimed that China applied a 17% VAT rate on semiconductor chips that were designed and made outside China, but gave VAT rebates to domestic producers. Following consultations with the Chinese government, the USTR announced on July 8, 2004, that China agreed to end its preferential tax policy by April 2005. However, the USTR has expressed concern over new forms of financial assistance given by the Chinese government to its domestic semiconductor industry.

VIOLATIONS OF U.S. INTELLECTUAL PROPERTY RIGHTS History of U.S. Efforts to Improve China’s IPR Regime The United States has pressed China to improve its IPR protection regime since the late 1980s. In 1991, the United States (under a Section 301 case) threatened to impose $1.5 billion in trade sanctions against China if it failed to strengthen its IPR laws. Although China later implemented a number of new IPR laws, it often failed to enforce them, which led the United States to once again threaten China with trade sanctions. The two sides reached a trade agreement in 1995, which pledged China to take immediate steps to stem IPR piracy by cracking down on large-scale producers and distributors of pirated materials and prohibiting the export of pirated products, establishing mechanisms to ensure 28

Some programs give tax preferences, tariff exemptions, discounted loans, or other benefitsto firms that meet certain export performance requirements, while others give tax breaksfor purchasing Chinese-made equipment and accessories over imports.

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long-term enforcement of IPR laws and providing greater market access to U.S. IPR-related products. Under the terms of China’s WTO accession (see above), China agreed to immediately bring its IPR laws in compliance with the TRIPS agreement. The U.S. Trade Representative’s (USTR) office has stated on a number of occasions that China has made great strides in improving its IPR protection regime, noting that it has passed several new IPR-related laws, closed or fined several assembly operations for illegal production lines, seized millions of illegal audio-visual products, curtailed exports of pirated products, expanded training of judges and law enforcement officials on IPR protection, and expanded legitimate licensing of film and music production in China. However, the USTR has indicated that much work needs to be done to improve China’s IPR protection regime. IPR protection has become one of the most important bilateral trade issues between the United States and China in recent years: •

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During the April 2004 U.S.-China Joint Commission on Commerce and Trade (established in 1983) meeting, the Chinese government pledged to “significantly reduce” IPR infringement levels by increasing efforts to halt production, imports, and sales of counterfeit goods and lowering the threshold for criminal prosecution of IPR violations. On November 19, 2004, eight members of the House Ways and Means Committee sent a letter to the Chinese Ambassador to the United States expressing concern that proposed Chinese regulations on government procurement of software would virtually lock out U.S. software companies due to requirements for local content and technology transfer. On December 16, 2004, General Motors Daewoo Auto & Technology Company (a division of General Motors) filed a case in China against Chery Automobile Co. Ltd. (a Chinese firm) for allegedly violating its IPR by copying one of its car models (the Chevrolet Spark) to produce the Chery QQ. The two companies reportedly settled the issue in November 2005.29 On February 9, 2005, the International Intellectual Property Alliance and the U.S. Chamber of Commerce urged the USTR to initiate WTO consultations with China over its poor record on IPR enforcement. On April 29, 2005, the USTR announced that it had placed China on the Special 301 “Priority Watch List,” due to “serious concerns”over China’s compliance with its WTO IPR obligations and China’s failure to fully

Asia Wall Street Journal, November 21, 2005.


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implement its pledges on IPR made in April 2004 to make a significant reduction in IPR piracy. The USTR urged China to launch more criminal piracy cases and to improve market access for IPR-related products, and warned that it was considering taking a case to the WTO if IPR enforcement did not soon show significant improvement. During the July 2005 U.S.-China Joint Commission on Commerce and Trade (JCCT)30 meeting, China agreed to boost enforcement of IPR, such as increasing criminal prosecutions of IPR offenders, improving cooperation among Chinese enforcement officials and between U.S. and Chinese IPR officials, and taking special steps to halt movie and internet piracy. It also pledged to improve government coordination of enforcement efforts, and to ensure the use by all levels of the Chinese government (including state-owned firms) of legitimate software products. In addition, the Chinese government agreed to delay implementing proposed regulations restricting government purchases of foreign-made software. On October 26, 2005, the United States initiated a special process under WTO rules to obtain detailed information on China’s IPR enforcement efforts. However, on December 22, 2005, China responded by challenging the legal basis for such a request in the WTO and subsequently refused to provide the data. During the JCCT meeting on April 11, 2006, China pledged to improve IPR protection by requiring that computers manufactured in China contain legitimate software. On April 19, 2006, Chinese president Hu asserted that licensed computer software was being introduced in all levels of government and that in 2006 this would be extended to include large state enterprises. On April 28, 2006, the USTR listed China as a Priority Foreign Country in its Special 301 report, and stated that, based on China’s limited progress in improving its IPR enforcement regime, the USTR was close to filing a WTO dispute case against China. In addition, the USTR indicated that next year’s Special 301 report would include a survey of

The JCCT was established in 1983 to serve as a forum for high-level dialogue on bilateraltrade issues. In 1994, it was enhanced by the establishment of specific working groups,which have grown to include trade and investment issues, business development andindustrial cooperation, commercial law, textiles, IPR, trade remedies, statistics, travel andtourism, high-tech and strategic trade, and agricultural trade.

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China’s IPR protection practices at the provincial level.31 The 2006 report identified Guangdong Province, Beijing City, Zhejiang Province, and Fujian Province as “hot spots” that required additional attention and resources for IPR enforcement. The report stated that, despite some improvements, China had failed to meet its April 2004 commitments to substantially reduce the level of IPR piracy. On December 12, 2007, the Motion Pictures Association of America, Inc. issued a press release stating that “China may have instituted a block on the import of American films into their country.”32 Although Chinese officials said no such ban was in effect, several U.S. industry officials claimed that such restrictions were in place and speculated they were in retaliation over the U.S. WTO cases against China involving IPR issues.33

The Scope of the IPR Piracy Problem in China U.S. firms contend that IPR piracy in China has worsened in recent years, despite Chinese government promises to strengthen IPR enforcement by increasing criminal prosecutions of IPR offenders (and toughening penalties), improve coordination among IPR enforcement officials, and make a long term concentrated effort to stamp out major piracy centers.34 Many business groups contend that poor IPR protection is one of the most significant obstacles for doing business in China. According to a representative of the Motion Picture Association of America, “China is the most difficult market to crack for the U.S. motion picture industry.” Nine out of ten movie DVDs are fake, and 2005 losses from piracy in China were estimated at $244 million.35 Major causes of the high 31

This appears to be motivated by the belief that since IPR enforcement is particularly badat the local level, the designation or description of specific provinces might prompt officialsthere to boost their enforcement efforts. 32 Press release available at [http://www.mpaa.org/PressReleases.asp]. 33 New York Times, “China Said to Block U.S. Films,” December 11, 2007. 34 Often the Chinese government will announce a major campaign to crack down on piracy,conducting widespread raids, shutting down illegal factories, and destroying piratedproducts. However, once the campaign period is over, enforcement becomes lax, and theillegal activity resurfaces. As a result, the long term result of the government’s antipiracycampaign is negligible. 35 Statement by Dan Glickman, Chairman and Chief Executive Officer, Motion PictureAssociation of America before the House Ways & Means Committee, Subcommittee onTrade, hearing on Trade With China, February 15, 2007.


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piracy levels in China are attributed to be the Chinese government’s tight restrictions on the number of foreign movies allowed to be imported (20 per year), extensive periods of government review and censure requirements before a foreign movie can be legitimately shown, tight limits on distribution of films by foreign companies, and government pressure on movie houses to show only Chinese-made movies. American music producers have faced similar problems in terms of high piracy rates in China (estimated at 85%), trade and investment barriers on legitimate products, and large-scale exports of pirated music CDs by illegal Chinese firms. Piracy of music and recordings is estimated to have cost U.S. firms $206 million in 2006, according to the IIPA.36 Pirated music, music videos, and movies are also widely distributed over the Internet in China.37 The Chinese government estimates that counterfeits constitute between 15% and 20% of all products made in China and are equivalent to about 8% of China’s annual gross domestic product. A study by the Motion Picture Association of America estimated that China’s domestic film industry lost about $1.5 billion in revenue to piracy in 2005 (and that the combined losses of both foreign and Chinese film makers totaled $2.7 billion).38 It also found that about half of pirated films in China are Chinese movies. The Chinese government estimates that 500 million pirated books are produced each year.39 Press reports indicate a number of health and safety problems resulting from counterfeit products in China. For example, in 2004, 13 infants in China reportedly died, and hundreds were sickened, from drinking fake baby formula.40 Many observers contend that, without a solid IPR enforcement regime, innovation and growth of IPR-related industries in China will likely be greatly retarded. Opinions differ as to why the Chinese government has been unable make a significant reduction in the level of piracy in China. Some explanations put forward by various analysts include the following:

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China’s transformation from a Soviet-style command economy (in which the government owned and controlled nearly every aspect of the economic life) to one that is becoming more market-based is a very

The International Federation of the Phono-graphic Industry (IFPI) estimates that morethan 350 million illegal discs were sold in China in 2005. 37 IPR piracy has become so prevalent in China that it has produced a number of humorousquips, such as “if you did not see a fake DVD, you were not in China,” and (in Shanghai)“we can copy everything except your mother.” 38 Reuters, “China Piracy Costs Film Industry $2.7 Billion in 2005,” June 19, 2006. 39 Xinhua News Agency, March 19, 2007. 40 New York Times, “China: Prison for Two in Baby Formula Scandal,” August 6, 2004, p.A4.

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recent occurrence. IPR is a relatively alien or unfamiliar concept for most people in China to grasp (as is the concept of private property rights) and thus it is difficult for the government to convince the public that piracy is wrong.41 Chinese leaders want to make China a major producer of capital-intensive and high-technology products and thus they are tolerant of IPR piracy if its helps Chinese firms become more technologically advanced.42 While the central government may be fully committed to protection of IPR, local government officials are often less enthusiastic to do so because production of pirated products generates jobs and tax revenue, and some officials may be obtaining bribes or other benefits which prompts them to tolerate piracy. As a developing country, China (like many other developing countries) lacks the resources and a sophisticated legal system to go after and punish IPR violators, and that establishing an effective enforcement regime will take time.43 As a practical matter, IPR enforcement in China will always be problematic until Chinese-owned companies begin to put pressure on the government to protect their own brands and other IPR-related products. Chinese trade barriers and regulatory restrictions on IPR-related products and their distribution are so onerous that they prevent legitimate products from entering the market, or raise costs so high that they are unaffordable to the average individual, thus creating a huge demand for low-cost pirated products.

The U.S. Files Two WTO Cases Against China on IPR U.S. trade officials were reportedly on the verge of filing a WTO dispute resolution case against China in the fall of 2006 over its inadequate IPR enforcement, but were convinced by the Chinese government to give them more 41

Some Chinese officials have noted that some individuals who were arrested for IPR piracyviolations expressed shock at their arrest because in their minds they were not harming anybody. 42 On the other hand, IPR piracy may prevent foreign firms from investing in high-techproduction in China. 43 Some critics of this argument note that China seems to be very efficient at going afterpolitical dissenters and others deemed to be “threats” to social stability.


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time to implement new IPR enforcement policies. In addition, U.S. officials indicated that they were are in the process of building a WTO case on IPR that would also include Chinese trade barriers to IPR-related products (which is seen as a major factor in the high piracy rates in China).44 Despite various efforts on the part of the Chinese government to improve IPR enforcement, the USTR decided to file two WTO cases against China on April 10, 2007.45 The U.S. WTO cases on China’s IPR regime represent the most comprehensive and complex cases the United States has filed against any WTO to date. Most WTO cases involve specific restrictions on specific products; however these two cases challenge a broad range of China’s IPR policies, and could potentially lead the WTO to authorize the United States to impose a significant level of sanctions against China.46 Specifically, the U.S. WTO complaints against China’s IPR regime involve the following issues:47

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The thresholds for criminal prosecutions of IPR violations are too high, meaning the government will only pursue cases it considers to be serious or excessively large, creating a safe harbor for smaller producers or violators. In addition, the thresholds for prosecuting IPR violations are based on the value of the pirated products rather than the value such legitimate products would fetch in the marketplace. Such thresholds make it very difficult to pursue cases against many commercial producers of illegal IPR-related products. China often allows seized imported pirated goods to re-enter the market rather than disposing of them. China’s copyright laws fail to protect imported works (such as movies) that are under review by Chinese censorship authorities (and must be approved before the works can be distributed in China). As a result, pirated copies of the works can be widely distributed without violating copyright law and thus do not face prosecution.

Inside U.S. Trade, February 21, 2007. For example, the Chinese government claimed it seized 73 million pirated products in 2006, made improvements to its legal system and increased prosecutions, and that itdeveloped a national comprehensive strategy to deal with piracy. 46 If the cases go to a WTO dispute resolution panel, and that panel ruled in favor of theUnited States, the panel would seek to estimate that level of trade losses suffered by theUnited States due to China’s failure to enforce its IPR laws or to provide market access toIPR-related products. This figure could potentially be over a billion dollars (based on U.S.industry estimates of trade losses from IPR piracy in China). 47 See USTR April 9, 2007 Press Release and related documents at[http://www.ustr.gov/index.html]. 45

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Chinese IPR laws do not appear to allow producers of pirated products to be prosecuted unless they also illegally distribute such products. China has not abided by its 2001 WTO accession agreement to liberalize its rules on trading rights and distribution services. As a result, U.S. IPRrelated products face significant trade barriers in China, and such barriers are a major factor for causing the high rate of piracy in China.

The USTR’s 2007 Special 301 Report (issued on April 30, 2007) stated that its top IPR protection and enforcement priorities were China (along with Russia). The report stated that Chinese counterfeit products, such as pharmaceuticals, electronics, batteries, auto parts, industrial equipment, and toys “pose a direct threat to the health and safety of consumers in the United States, China and elsewhere.” The report also included a special province-by-province assessment of IPR protection, the first time such a assessment has been made of any country.

APPLYING U.S. COUNTERVAILING LAWS TO CHINA48 Many critics of Chinese trade policies contend that the Chinese government provides a significant level of subsidies to many of its industries, such as preferential bank loans and grants, debt forgiveness, and tax breaks and rebates.49 In addition, some analysts charge that China’s currency policy constitutes a form of government export subsidy.50 Such critics contend that U.S. countervailing laws, which seek to address the negative impact foreign government subsides on exported products may have on U.S. producers in the United States, should be applied to nonmarket economies such as China.51 Until very recently, the Commerce Department contended that U.S. countervailing laws could not be applied to a non-market economy because of the assumption that most production and prices in such an economy are determined by the government, and thus it would be impractical to determine the level of 48

For additional information on this issue, see CRS Report RL33550, Trade RemedyLegislation: Applying Countervailing Action to Nonmarket Economy Countries, by VivianC. Jones. 49 See USTR 2007 National Trade Estimates of Foreign Trade Barriers, April 2, 2007. 50 They charge that government intervention in currency markets to keep the value of theyuan low vis-a-vis the dollar, keeps the price of Chinese exports low. 51 The relief comes in the form of additional duties that are imposed on the importedproducts in question after a determination is made that a foreign government subsidizedexport to the United States has harmed a U.S. producer. The additional duties are intendedto offset the impact of the subsidy.


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government subsidy that might be conveyed to various exported products. However, in November 2006, the Commerce Department decided to pursue a countervailing case against certain imported Chinese coated free sheet paper products. On March 30, 2007, the Commerce Department issued a preliminary ruling to impose countervailing duties (ranging from 11% to 20%) against the products in question. Commerce contends that, while China was still a non-market economy for the purposes of U.S. trade laws, economic reforms in China have made several sectors of the economy relatively market based, and therefore it is possible to identify the level of government subsidies given to the Chinese paper firms in question.52 Many Members of Congress have called on the Administration to expand its use of countervailing measures against other Chinese products (as well to apply the law to the products of other nonmarket economies), and some have argued that Commerce should consider China’s undervalued currency as a factor in determining the level of countervailing duties.53

TEXTILE AND APPAREL PRODUCTS54 Various U.S. industry groups have called on the Administration to invoke special safeguard provisions (included in China’s WTO accession package) that would enable the United States to restrict imports of certain Chinese products deemed harmful to U.S. industries. U.S. producers of textile and apparel products have been particularly vocal over the competitive pressures they face from China, especially since U.S. textile and apparel quotas on Chinese goods were eliminated in January 2005.55 According to the U.S. Commerce Department, China is the largest foreign supplier of textiles and apparel to the United States at $37.5 billion, or 34.9%(2007), and were nearly double 2004 levels ($19.2 billion).56 52

Countervailing investigations have also been initiated of Chinese off-the-road tires (June18, 2007) and Chinese steel pipe (June 14, 2007). 53 Legislation has been introduced in the 110th Congress that would clarify U.S. law toindicate that countervailing laws can apply to nonmarket economies. Other proposedlegislation make “currency manipulation” or “currency misalignment” actionable under U.S.countervailing laws (see section on legislation). 54 For additional information, see CRS Report RL34106, U.S. Clothing and Textile Tradewith China and the World: Trends Since the End of Quotas, by Michael F. Martin. 55 For additional information on U.S.-China textile issues, see CRS Report RL32168,Safeguards on Textile and Apparel Imports from China, by Vivian C. Jones. 56 For more detailed data on U.S. imports of textile and apparel products from China, seeDepartment of Commerce, Office of Textiles and Apparel Office website at[http://www.otexa.ita.doc.gov/].

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The sharp rise in textile and apparel imports from China, and U.S. industry contention that these imports were disrupting U.S. markets, led the Administration to seek an agreement with China to limit its exports to the United States. On November 8, 2005, China agreed to restrict various textile and apparel exports to the United States (according to specified quota levels) from January 2006 through the end of 2008.

THE U.S.-CHINA STRATEGIC ECONOMIC DIALOGUE (SED) On September 29, 2006, President Bush and Chinese President Hu agreed to establish a Strategic Economic Dialogue (SED) in order to have discussions on major economic issues at the “highest official level.” According to a U.S. Treasury Department press release, the intent of the SED is to “discuss long-term strategic challenges, rather than seeking immediate solutions to the issues of the day,” in order to provide a stronger foundation for pursuing concrete results through existing bilateral economic dialogues.57 The first meeting (chaired by Secretary of Treasury Paulson and Chinese Vice Premier Wu Yi) was held on December 14-15, 2006. The two sides have focused on four main topics: macroeconomic policy (including China’s currency policy), innovation and IPR protection, energy and the environment, and services trade and investment. The United States has sought to use the talks to induce China to: quicken the pace of its currency reforms, expand market access for financial and non-financial services (beyond its WTO accession commitments), take steps to boost domestic consumption (including developing a social safety net), improve the business climate in China (such as transparency), and to address U.S. high priority trade issues (such as Chinese restrictions on U.S. beef, IPR protection, and health and safety issues regarding Chinese food products). The second round of SED talks were held on May 22-23, 2007, in Washington, DC. The Chinese delegation was led by Chinese Vice Premier Wu Yi and included representatives from 15 ministries. According to the Treasury Department, China agreed to:

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Resume licensing for qualified joint ventures with foreign securities firms in China and expand the scope of their operations (such as in securities brokerages, propriety trading, and asset management), increase the level of permitted foreign investment (by qualified entities) in China’s

U.S. Treasury Department press release, December 15, 2006.


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securities markets (e.g., stocks, bonds, etc.), and expand the scope of overseas equity investments that Chinese nationals are allowed to make through domestic entities. Allow foreign banks in China to issue RMB bank cards. Double the number of daily U.S. passenger flights to China by 2012 and provide full liberalization for cargo providers by 2011. Expand cooperation with the United States on sharing data on seizures of pirated goods in order to track violators. Increase cooperation and lower barriers for bilateral trade in environmental goods and services.

The December 2007 SED talks focused on a number of issues, many of which led to formal agreements, including:58 •

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a Memorandum of Understanding (MOU) on illegal logging and associated trade. The MOU establishes a Bilateral Forum between the two countries to identify joint work promoting both sustainable forest management and trade in legally-sourced forest products, as well as encourage public-private partnerships; MOAs on food and feed and on drugs and medical products; an MOA on strengthening cooperation on sound environmental management practices related to trade; an MOU to expand collaboration and cooperation for the exchange of information on regulatory standards for alcohol and tobacco products, and to improve the safety of imports and exports between the two countries; an MOU on biofuels, including cooperation on scientific, technical, and policy aspects of biofuels development, production, and use; an MOU on bilateral tourism promotion; an agreement on “Guidelines for U.S.-China High-Technology and Strategic Trade Development” to expand information sharing on market opportunities, and to identify and remove trade barriers; an MOU to expand U.S. exports to major urban areas in China; a memorandum of cooperation (MOC) to launch the Environmental Industries Forum, a forum of public and private sector groups, to promote

Note, some of these agreements occurred during the December 11, 2007 JCCT meeting,which was held right before the SED meeting (December 12-13).

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the deployment of environmental technologies in China and increased trade in environmental goods and services; and renewal of a 2002 protocol promoting cooperation and collaboration on agricultural science and technology, and renewal and expansion of a 2002 MOU on cooperation in fighting HIV/AIDS.

The two sides also agreed to expand cooperation in the following areas: ! the use of strategic oil reserves; ! the use of low-sulfur fuels; • •

clean water (the United States will provide technical assistance to China); and improved transparency on trade issues.

In addition, China agreed to allow foreign companies doing business in China to issue RMB-denominated stocks and bonds, and to complete a study with recommendations on adjusting the extent of foreign equity participation in the securities sector. The United States agreed to allow mutual funds administered by Chinese banks to invest in the U.S. stock market. China also agreed to re-list six of the 11 U.S. plants that had been de-listed for export to China because of Chinese claims that a feed additive (ractopamine) was unsafe. Some Members expressed disappointment that the latest SED round did not contain commitments by China to further reform its currency policy, expand market access for U.S. financial firms, or to open China’s markets to U.S. beef exports.

U.S.-CHINA TRADE LEGISLATION IN THE 110TH CONGRESS Several bills have been introduced in the 110th Congress to address various concerns over China’s economic policies, especially its currency policy.

Currency Legislation A significant share of trade legislation aimed at China involves efforts to change China’s currency policy. The bills reflect various approaches. Some would impose tariffs against Chinese products (equal to the estimated undervaluation of China’s currency) if China does not appreciate its currency to market levels. Another approach would apply U.S. countervailing laws to


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China’s currency policy in the belief that such a policy constitutes a government subsidy. Some bills would change U.S. law regarding the Treasury Department’s bi-annual determination of countries that manipulate their currencies. For example, some would replace the term currency “manipulation” with currency “misalignment” and would change factors Treasury would have to consider when determining which countries to cite, thus increasingly the likelihood that Treasury would have to designate China.59 A final approach would make China’s undervalued currency a factor in U.S. antidumping cases. Major currency legislation includes: •

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H.R. 321 (English) would require the Treasury Department to determine if China manipulated its currency and to estimate the rate of that manipulation (if such a determination were made), which then would require the imposition of additional tariffs on Chinese products (equal to the estimated rate of manipulation). The bill also calls on the United States to file a WTO case against China over its currency policy and to work within the WTO to modify and clarify rules regarding currency manipulation. H.R. 782 (Tim Ryan) and S. 796 (Bunning) would make exchange rate “misalignment” actionable under U.S. countervailing duty laws, require the Treasury Department to determine whether a currency is misaligned in its semi-annual reports to Congress on exchange rates, prohibit the Department of Defense from purchasing certain products imported from China if it is determined that China’s currency misalignment has disrupted U.S. defense industries, and would include currency misalignment as a factor in determining safeguard measures on imports of Chinese products that cause market disruption. H.R. 1002 (Spratt) would impose 27.5% in additional tariffs on Chinese goods unless the President certifies that China is no longer manipulating its currency. H.R. 708 (English), H.R. 1229 (Davis) and S. 974 (Collins) would apply U.S. countervailing laws to non-market economies. S. 364 (Rockefeller) would apply U.S. countervailing laws to non-market economies and make exchange rate manipulation actionable under those laws.

Current U.S. law implies that there has to be intent to prevent an effective balance ofpayments or to seek an unfair competitive advantage before a country can be designated asa currency manipulator. Some of the proposed currency bills attempt to factor out this“technicality” so that a designation would occur as long as if Treasury found that a currencywas fundamentally misaligned.

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Congressional Research Service •

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H.R. 2942 (Tim Ryan) would apply countervailing laws to nonmarket economies, make an undervalued currency a factor in determining antidumping and countervailing duties, require Treasury to identify fundamentally misaligned currencies and to list those meeting the criteria for priority action. If consultations fail to resolve the currency issues, the USTR would be required to take action in the WTO. S. 1607 (Baucus) would require the Treasury Department to identify currencies that are fundamentally misaligned and to designate such currencies for priority action under certain circumstances in its semiannual reports to Congress on exchange.60 If after consultations the country maintaining the designated currency policy fails to adopt appropriate policies, the U.S. would make currency undervaluation a factor in determining antidumping duties, ban federal procurement of products or services from the designated country, bar financing by the U.S. Overseas Private Investment Corporation (OPIC),61 and would oppose multilateral financing for that country. If the designated country failed to take appropriate measures, the USTR would be required to file a case in the WTO. A modified version of the bill passed the Senate Finance Committee on July 31, 2007. S. 1677 (Dodd) would require the Treasury Department to identify countries that manipulate their currencies regardless of their intent and to submit an action plan for ending the manipulation; and gives Treasury the authority to file a case in the WTO. The bill was approved by the Senate Banking Committee on August 1, 2007.

Other Legislation Other proposed bills that would affect commercial relations with China include: • •

H.Res. 552 (Marshall) calls on China to remove barriers to U.S. financial services firms doing business in China. H.Res. 730 (Ros-Lehtinen) expresses the sense of the House regarding the planned acquisition of a minority interest in 3Com Corporation (a U.S. producer of data-networking equipment) by affiliates of Huawei Technologies (a Chinese company).

China - U.S. Trade Issues •

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H.Res. 925 (Poe) would condemn China for its socially unacceptable business practices, including the manufacturing and exportation of unsafe products, casual disregard for the environment, and exploitative employment practices. H.R. 275 (Christopher Smith), the Global Online Freedom Act, attempts to promote free expression and a free flow of information on the Internet by preventing U.S. companies from aiding regimes who restrict access to the Internet. H.R. 388 (Kildee) would prohibit U.S. imports of Chinese autos as long as Chinese tariffs on autos are higher than U.S. tariffs. H.R. 571 (Tancredo) would raise tariffs on countries classified as nonmarket economies (including China). H.R. 1958 (Kaptur) and S. 571 (Dorgan) would terminate China’s permanent normal trade relations (PNTR) status and instead would reapply provisions of U.S. trade law that would extend conditional normal trade relations (NTR) status to China, renewable on an annual basis, as specified under Title IV of the 1974 Trade Act, as amended. H.R. 3220 and H.R. 3221 (both by Pelosi) would (among other things) promote U.S. exports of clean and efficient energy technologies to China (and India) and help build the capacity of government officials to become more familiar with available clean and efficient technologies. H.R. 3272 (Kirk) would provide for increased funding and support for diplomatic engagement with China and would provide funding for rule of law programs in China. H.R. 3273 (Larsen) seeks to expand U.S. export promotion programs in order to boost exports to China by small and medium-sized firms. H.R. 3274 (Israel) would authorize the Secretary of Energy to make grants to encourage cooperation between the United States and China on joint research, development, or commercialization of carbon capture and sequestration technology, improved energy efficiency, or renewable energy sources. H.R. 3275 (Davis) would, for the purpose of boosting U.S. global economic competitiveness, provide resources to U.S. schools in order to provide Chinese language and cultural studies classes. S. 1919 (Baucus) would (among other things), limit the discretion of the president in regards to Section 421 (China-specific safeguards) investigations on import surges from China and would amend U.S. trade law to apply U.S. countervailing laws to nonmarket economies.

Chapter 5

CHINA’S ECONOMIC CONDITIONS* Congressional Research Service SUMMARY Since the initiation of economic reforms in 1979, China has become one of the world’s fastest-growing economies. From 1979 to 2007 China’s real gross domestic product (GDP) grew at an average annual rate of 9.8%. Real GDP grew 11.4% in 2007 (the fastest annual growth since 1994). While China is expected to continue to enjoy rapid economic growth in the years ahead and could become the world’s largest economy within a decade or so, it faces a number of challenges, including widespread corruption, an inefficient banking system, over-dependence on exports and fixed investment for growth, pollution, widening income disparities, and growing inflationary pressures. The Chinese government has indicated that it intends, over the coming years, to create a “harmonious society” that would promote more balanced economic growth and address a number of economic and social issues. Trade and foreign investment continues to play a major role in China’s booming economy. From 2004 to 2007, the value of total Chinese merchandise trade nearly doubled. In 2007, China’s exports (at $1,218 billion) exceeded U.S. exports (1,162 billion) for the first time. China’s imports were $956 billion and its trade surplus was $262 billion (a historic high). Well over half of China’s *

This is an edited, reformatted and augmented version of a Congressional Research Service publication, Order Code RL33534, updated March 11, 2008.

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trade is conducted by foreign firms operating in China. The combination of large trade surpluses, foreign direct investment flows, and large-scale purchases of foreign currency have helped make China the world’s largest holder of foreign exchange reserves at $1.5 trillion at the end 2007. China’s economy continues to be a concern to many U.S. policymakers. On the one hand, U.S. consumers, exporters, and investors have greatly benefitted from China’s rapid economic and trade growth. On the other hand, the surge in Chinese exports to the United States has put competitive pressures on various U.S. industries. Many U.S. policymakers have argued that China often does not play by the rules when it comes to trade and they have called for greater efforts to pressure China to fully implement its World Trade Organization (WTO) commitments and to change various economic policies deemed harmful to U.S. economic interests, such as its currency policy, its use of subsidies to support state-owned firms, trade and investment barriers to U.S. goods and services, and failure to ensure the safety of its exports to the United States. Concerns have also been raised over China’s rising demand for energy and raw materials, its impact on world prices for such commodities, increased pollution levels, and efforts China has made to invest in energy and raw materials around the world, including countries (such as Iran, North Korea, and Sudan) where the United States has political and human rights concerns. This chapter provides an overview of China’s economic development, challenges China faces to maintain growth, and the implications of China’s rise as a major economic power for the United States.

CHINA’S ECONOMIC CONDITIONS The rapid rise of China as a major economic power within a time span of about 30 years is often described by analysts as one of the greatest economic success stories in modern times. From 1979 (when economic reforms began) to 2007, China’s real gross domestic product (GDP) grew at an average annual rate of over 9.8%; in 2007, it rose by 11.4%. The Chinese economy in 2007 (in real terms) was nearly 14 times larger than it was in 1979, and real per capita GDP was more than 10 times larger. By some measurements, China is now the world’s second largest economy and some analysts predict it could become the largest within a decade or two. China’s economic rise has led to a substantial increase in U.S.-China economic relations. Total trade between the two countries surged from $5 billion in 1980 to and estimated $389 billion in 2007. For the United States, it is

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estimated that in 2007, China was its 2nd largest trading partner, its 3rd largest export market, and its largest source of imports. Many U.S. companies have extensive manufacturing operations in China in order to sell their products in the booming Chinese market and to take advantage of low cost labor for manufacturing products for export. These operations have helped U.S. firms remain internationally competitive and have supplied U.S. consumers with a variety of low cost goods. China’s large-scale purchases of U.S. Treasury securities have enabled the federal government to fund its budget deficits and keep U.S. interest rates relatively low. However, the emergence of China as a major economic superpower has raised concern among many U.S. policymakers. Some express concern over the large and growing U.S. trade deficits with China, which have risen from $10.4 billion in 1990 to $256 billion in 2007, and are viewed by many Members as an indicator that U.S.-Chinese commercial relations are imbalanced or unfair. Others claim that China uses unfair trade practices (such as an undervalued currency and subsidies to domestic producers) to flood U.S. markets with low cost goods, and that such practices threaten American jobs, wages, and living standards. Congressional concerns over perceived negative China’s economic practices have led to the introduction of numerous bills in the 110th Congress, some of which would impose restrictions on imported Chinese products. While most economists contend China will continue to experience rapid economic growth over the next several years, they note that it faces a number of significant challenges, including a weak banking system, widening income gaps, growing pollution, unbalanced economic growth (through over-reliance on exports), and widespread economic efficiencies resulting from non-market policies. This chapter provides background on China’s economic rise and current economic structure and the challenges China faces to keep its economy growing strong, and describes Chinese economic policies that are of concern to U.S. policymakers.

MOST RECENT DEVELOPMENTS •

On March 10, 2008, the Bank of China reported the exchange rate between the yuan and the dollar at 7.11. The government also reported that China’s imports and exports in February 2008 rose by 35.1% and 6.5% respectively over the same month in 2007. China’s exports to the


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•

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•

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United States were down 5.3% while imports from the United States jumped 47.8%. On February 19, 2008, the Chinese government reported that the consumer price index (CPI) had risen by 7.1% in January 2008 over the same month in 2007, and the CPI for foodstuff was up 18.2%, raising concerns in China that inflation could threaten future economic growth. [1] On January 24, 2008, the Chinese government reported that real GDP grew by 11.4% in 2007 over the previous year, the highest rate of growth since 1994. In addition, exports hit $1.2 trillion. On September 29, 2007, the Chinese government officially launched the China Investment Corporation (under the direction of the State Council) in an effort to better manage its foreign exchange reserves. It reportedly will initially manage over $200 billion, making it one of the world’s largest state-owned funds. On June 29, 2007, the Chinese National People’s Congress passed a new contract labor law intended to improve labor rights and stop abuses (such as unpaid labor and forced overtime). The law passed two weeks after the Chinese media reported that government raids had uncovered evidence that hundreds of people (including many children) had been forced to work as virtual slaves in illegal brick kilns and coal mines in northern China. China’s Xinhua News Agency stated that reports of such abuses have “sparked a nationwide outcry.” [2] On June 22, 2007, the Netherlands Environmental Assessment Agency announced that, according to its estimates, China in 2006 became the world’s largest emitter of CO2, surpassing the United States by 8%.

AN OVERVIEW OF CHINA’S ECONOMIC DEVELOPMENT China’s Economy Prior to Reforms Prior to 1979, China maintained a centrally planned, or command, economy. A large share of the country’s economic output was directed and controlled by the state, which set production goals, controlled prices, and allocated resources throughout most of the economy. During the 1950s, all of China’s individual household farms were collectivized into large communes. To support rapid industrialization, the central government undertook large-scale investments in


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physical and human capital during the 1960s and 1970s. As a result, by 1978 nearly three-fourths of industrial production was produced by centrally controlled state-owned enterprises according to centrally planned output targets. Private enterprises and foreign-invested firms were nearly nonexistent. A central goal of the Chinese government was to make China’s economy relatively self-sufficient. Foreign trade was generally limited to obtaining only those goods that could not be made or obtained in China. Government policies kept the Chinese economy relatively stagnant and inefficient, mainly because there were few profit incentives for firms and farmers; competition was virtually nonexistent, and price and production controls caused widespread distortions in the economy. Chinese living standards were substantially lower than those of many other developing countries. The Chinese government hoped that gradual reform would significantly increase economic growth and raise living standards.

THE INTRODUCTION OF ECONOMIC REFORMS Beginning in 1979, China launched several economic reforms. The central government initiated price and ownership incentives for farmers, which enabled them to sell a portion of their crops on the free market. In addition, the government established four special economic zones along the coast for the purpose of attracting foreign investment, boosting exports, and importing high technology products into China. Additional reforms, which followed in stages, sought to decentralize economic policymaking in several sectors, especially trade. Economic control of various enterprises was given to provincial and local governments, which were generally allowed to operate and compete on free market principles, rather than under the direction and guidance of state planning. Additional coastal regions and cities were designated as open cities and development zones, which allowed them to experiment with free market reforms and to offer tax and trade incentives to attract foreign investment. In addition, state price controls on a wide range of products were gradually eliminated.

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CHINA’S ECONOMIC GROWTH SINCE REFORMS: 1979-PRESENT Since the introduction of economic reforms, China’s economy has grown substantially faster than during the pre-reform period (see Table 1). From 1960 to 1978, real annual GDP growth was estimated at 5.3% (a figure many analysts claim is overestimated, based on several economic disasters that befell the country during this time, such as the Great Leap Forward from 1958-1960 and the Cultural Revolution from 1966-1976). During the reform period (1979-the present), China’s average annual real GDP grew by 9.8%; it grew by an estimated 11.4% in 2007 over the previous year. Since economic reforms were begun, the size of the economy in real terms has increased 14-fold, and real per capita GDP (a common measurement of living standards) has gone up 10-fold. [3] Table 1. China’s Average Annual Real GDP Growth: 1960-2007 Time Period 1960-1978 (pre-reform) 1979-2007 (post-reform) 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Average Annual Growth (%) 5.3 9.8 3.8 9.3 14.2 14.0 13.1 10.9 10.0 9.3 7.8 7.6 8.4 8.3 9.1 10.0 10.1 9.9 11.1 11.4

Source: Official Chinese government data and Economist Intelligence Unit.


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CAUSES OF CHINA’S ECONOMIC GROWTH Economists generally attribute much of China’s rapid economic growth to two main factors: large-scale capital investment (financed by large domestic savings and foreign investment) and rapid productivity growth. These two factors appear to have gone together hand in hand. Economic reforms led to higher efficiency in the economy, which boosted output and increased resources for additional investment in the economy. China has historically maintained a high rate of savings. When reforms were initiated in 1979, domestic savings as a percentage of GDP stood at 32%. However, most Chinese savings during this period were generated by the profits of state-owned enterprises (SOEs), which were used by the central government for domestic investment. Economic reforms, which included the decentralization of economic production, led to substantial growth in Chinese household savings (these now account for half of Chinese domestic savings). As a result, savings as a percentage of GDP has steadily risen; it reached nearly 50% in 2005, among the highest savings rates in the world. Several economists have concluded that productivity gains (i.e., increases in efficiency in which inputs are used) were another major factor in China’s rapid economic growth. The improvements to productivity were caused largely by a reallocation of resources to more productive uses, especially in sectors that were formerly heavily controlled by the central government, such as agriculture, trade, and services. For example, agricultural reforms boosted production, freeing workers to pursue employment in the more productive manufacturing sector. China’s decentralization of the economy led to the rise of nonstate enterprises, which tended to pursue more productive activities than the centrally controlled SOEs. Additionally, a greater share of the economy (mainly the export sector) was exposed to competitive forces. Local and provincial governments were allowed to establish and operate various enterprises on market principles, without interference from the central government. In addition, foreign direct investment (FDI) in China brought with it new technology and processes that boosted efficiency.

CHINA’S INDUSTRIAL SECTOR China’s rapid economic growth has largely come from the expansion of its industrial manufacturing. As seen in Table 2, the total value-added output of all

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manufacturing rose by over 178% between 1995 and 2003. In 2003, the industries with the largest value-added output were electrical machinery, industrial chemicals, transport equipment, iron and steel, and non-electrical machinery (such as computers). An important factor in China’s rapid economic rise has been the decline of the state-owned or controlled enterprises relative to the private sector and foreign-owned enterprises. Before the 1979 reforms, stateowned enterprises (SOEs) accounted for about three-fourths of total industrial value-added output. In 2005, that share had declined to about 38%. About 28% of the valued-added industrial output came from foreign-invested firms in China and 18% from private Chinese companies. The rest came from locally owned town and village enterprises and various enterprises jointly owned by the state and private companies. According to the Economist Intelligence Unit (EIU), the number of SOEs fell from 118,000 in 1995 to 27,477 in 2005. [4] According to some estimates, Chinese SOEs have shed over 60 million of workers since 1998. Many SOEs have been transferred into state holding companies, which, while mainly state-owned, are run like private companies (and many of which are listed in various stock exchanges overseas, including in the United States). Table 2. Major Chinese Industries Based on Value-Added Output: 1995 and 2003 ($ millions and % change) 1995 2003 1995/2003 ($ millions) ($ millions) % Change Total Manufacturing 148,059 411,846 178.2 Electrical machinery 14,834 66,521 348.4 Industrial chemicals 16,888 45,727 170.8 Transport equipment 9,641 35,000 263.0 Iron and steel 12,612 34,119 170.5 Non-electrical machinery 13,401 31,395 134.3 Food products 8,476 25,776 204.1 Textiles 10,758 23,036 114.1 Tobacco 7,335 19,010 159.2 Other non-metallic mineral 10,776 16,334 51.6 products (such as china, pottery, earthenware, and glass products) Petroleum refineries 6,721 15,554 131.4

Source: 2006 China Statistical Yearbook.


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According to the Organization for Economic Cooperation and Development (OECD), the industries in China still dominated by SOEs (in 2003) include tobacco processing (SOEs control 98.6% of value added output), petroleum and natural gas extraction (93.8%), coal mining (81.4%), petroleum processing and coking (77.3%), smelting and pressing of ferrous metals (63.1%), and transport equipment (63.1%). [5]

MEASURING THE SIZE OF CHINA’S ECONOMY The actual size of the China’s economy has been a subject of extensive debate among economists. Measured in U.S. dollars using nominal exchange rates, China’s GDP in 2007 was $3.3 trillion; its per capita GDP (a commonly used living-standards measurement) was $2,510. Such data would indicate that China’s economy and living standards are significantly lower than those of the United States and Japan, respectively considered to be the number-one and number-two largest economies (see Table 3). Many economists, however, contend that using nominal exchange rates to convert Chinese data into U.S. dollars substantially underestimates the size of China’s economy. This is because prices in China for many goods and services are significantly lower than those in the United States and other developed countries. Economists have attempted to factor in these price differentials by using a purchasing power parity (PPP) measurement, which attempts to convert foreign currencies into U.S. dollars on the basis of the actual purchasing power of such currency (based on surveys of the prices of various goods and services) in each respective country. This PPP exchange rate is then used to convert foreign economic data in national currencies into U.S. dollars. Because prices for many goods and services are significantly lower in China than in the United States and other developed countries (while prices in Japan are higher), the PPP exchange rate raises the estimated size of Chinese economy from $3.3 trillion (nominal dollars) to $7.2 trillion (PPP dollars), significantly larger than Japan’s GDP in PPPs ($4.3 trillion), and a little over half the size of the U.S. economy. PPP data also raise China’s per capita GDP from $2,510 (nominal) to $5,420. The PPP figures indicate that, while the size of China’s economy is substantial, its living standards fall far below those of the U.S. and Japan. China’s per capita GDP on a PPP basis was only 11.82% of U.S. levels. Thus, even if China’s GDP were to overtake that of the United States in the next few decades, its living standards would likely remain substantially below those of the United States for many years to come. [6]


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Table 3. Comparisons of U.S., Japanese, and Chinese GDP and Per Capita GDP in Nominal U.S. Dollars and PPP, 2007

Country United States Japan China

Nominal GDP ($ billions) 13,843 4,384 3,316

GDP in PPP ($ billions) 13,843 4,270 7,168

Nominal Per Capita GDP 45,820 34,460 2,510

Per Capita GDP in PPP 45,820 33,500 5,420

Source: Economist Intelligence Unit (estimated, based on World Bank Data).

FOREIGN DIRECT INVESTMENT IN CHINA China’s trade and investment reforms and incentives led to a surge in foreign direct investment (FDI), which has been a major source of China’s capital growth. Annual utilized FDI in China (excluding the financial sector) grew from $636 million in 1983 to $75 billion in 2007. [7] The cumulative level of FDI in China at the end of 2007 stood at nearly $760 billion, making China one of the world’s largest destinations of FDI. Based on cumulative FDI for 1979-2007 about 40% of FDI in China has come from Hong Kong, 9.7% from the British Virgin Islands, [8] 8.1% from Japan, and 7.4% from the United States. (See Table 4). [9] The United States was China’s 5th largest source of U.S. FDI in 2007, accounting for 3.5% of total. [10] U.S. FDI flows to China peaked at $5.4 billion in 2002, but have declined every year since. U.S. FDI in China in 2007 fell by nearly 13% over the previous year. The largest sector for FDI flows to China in 2007 was manufacturing, which accounted for about 55% of total (see Table 5). [11] The Chinese government estimates that through June 2007, it had approved over 610,000 foreign funded companies and that 28 million people were employed by such firms (10% of all people employed in urban areas). [12]


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Table 4. Major Foreign Investors in China: 1979-2007

Country Total Hong Kong British Virgin Islands Japan United States Taiwan South Korea

($ billions and % of total) Cumulative Utilized Utilized FDI in FDI: 1979-2007 2007 % Change Amount % of Total Amount % of Total over 2006 760.2 100.0 74.8 100.0 13.4 300.0 39.5 20.2 37.1 30.0 9.7 16.6 22.1 41.8 73.8 8.1 7.4 6.0 5.1

61.2 56.6 45.7 38.7

3.6 2.6 1.8 3.7

4.8 3.5 2.4 4.9

-24.6 -12.8 -20.4 -7.9

Source: Invest in China, [http://www.fdi.gov.cn]. Top six investors according to cumulative FDI from 1979 to 2007. Data do not reflect FDI in the financial sector, which the government does not report by country. Note: Chinese data on FDI differ significantly from that of investor countries.

Table 5. Foreign Direct Investment by Sectors in 2007 Sectors Total Manufacturing Real Estate Development Leasing and Commercial Services Wholesale and Retail Trade Transport, Storage, and Posts

Utilized FDI ($ billions) $74.8 40.9 17.1 4.0 2.7 2.0

% of Total 100% 54.6 23.7 5.3 3.6 2.7

Source: Chinese National Bureau of Statistics.

CHINA’S TRADE PATTERNS Economic reforms have transferred China into a major trading power. Chinese exports rose from $14 billion in 1979 to $1,218 billion in 2007, while imports over this period grew from $16 billion to $956 billion (see Table 6). In 2004, China surpassed Japan as the world’s third-largest trading economy, after the European Union (EU) and the United States, and in 2007 it may have become


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the second largest exporter, surpassing the United States. China’s exports has grown dramatically in recent years, doubling in size from 2004 to 2007, with an average annual growth rate of 29%. Imports over this period increased by 70%. China’s trade surplus, which totaled $32 billion in 2004, surged to $262 billion in 2007. Table 6. China’s Merchandise World Trade, 1979-2007

Year 1979 1980 1985 1990 1995 2000 2001 2002 2003 2004 2005 2006 2007

($ billions) Exports Imports Trade Balance 13.7 15.7 -2.0 18.1 19.5 -1.4 27.3 42.5 -15.3 62.9 53.9 9.0 148.8 132.1 16.7 249.2 225.1 24.1 266.2 243.6 22.6 325.6 295.2 30.4 438.4 412.8 25.6 593.4 561.4 32.0 762.0 660.1 101.9 969.1 791.5 177.6 1,218.0 955.8 262.2

Source: International Monetary Fund, Direction of Trade Statistics and Global Trade Atlas (using official Chinese statistics).

Merchandise trade surpluses, large-scale foreign investment, and large purchases of foreign currencies to maintain its exchange rate with the dollar and other currencies have enabled China to accumulate the world’s largest foreign exchange reserves. China’s accumulation of foreign exchange reserves has been particularly acute over the past few years. China’s total reserves reached $1.5 trillion at the end of December 2007.

CHINA’S MAJOR TRADING PARTNERS China’s trade data often differ significantly from those of its major trading partners, especially with the United States. This is largely due to the large share


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of China’s trade (both exports and imports) passing through Hong Kong (which reverted back to Chinese rule in July 1997 but is treated as a separate customs area by most countries, including China and the United States). China treats a large share of its exports through Hong Kong as Chinese exports to Hong Kong for statistical purposes, while many countries that import Chinese products through Hong Kong generally attribute their origin to China for statistical purposes. According to Chinese trade data, its top five trading partners in 2007 were the European Union (EU), Japan, the United States, the 10 nations that constitute the Association of Southeast Asian Nations (ASEAN), and Hong Kong (see Table 7). China’s largest export markets were, the EU, the United States, and Hong Kong, while its top sources for imports were the Japan, the EU, and ASEAN (the United States ranked 6th). China maintained substantial trade surpluses with the United States, the EU, and Hong Kong, but had deficits with Japan and ASEAN. China reported that it had a $163 billion trade surplus with the United States (U.S. data show that it had a $256 billion deficit with China). Table 7. China’s Major Trading Partners: 2007 ($ billions)

Country European Union United States Japan ASEANa Hong Kong

Total Trade 356.2 302.1 236.0 202.5 197.2

Chinese Exports 245.2 232.7 102.1 94.2 184.3

Chinese China’s Trade Imports Balance 111.0 134.2 69.4 163.3 134.0 -31.9 108.4 -14.1 12.8 171.6

Source: China Monthly Statistics.

Note: Chinese data on its bilateral trade often differ substantially from the official trade data of many of its trading partners. a

Association of Southeast Asian Nations (ASEAN) member countries are Indonesia, Malaysia, the Philippines, Singapore, Thailand, Brunei, Cambodia, Laos, Myanmar (Burma), and Vietnam.

U.S. trade data indicate that the importance of the U.S. market to China’s export sector is likely to be much higher than is reflected in Chinese trade data. Based on U.S. data on Chinese exports to the United States and Chinese data on total Chinese exports, it is estimated that Chinese exports to the United States as a share of total Chinese exports totaled 33.6% in 2007. A growing level of Chinese exports is from foreign-funded enterprises (FFEs) in China. According to Chinese data, FFEs were responsible for 57% of Chinese exports in 2007

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compared with 41% in 1996. A large share of these FFEs are owned by Hong Kong and Taiwan investors, many of whom have shifted their labor-intensive, export-oriented, firms to China to take advantage of low-cost labor. A large share of the products made by such firms is likely exported to the United States.

MAJOR CHINESE TRADE COMMODITIES China’s abundance of cheap labor (the average labor cost per hour in China was $1.35, compared with $24.50 in the United States in 2006) [13] has made it internationally competitive in many low-cost, labor-intensive manufactures. As a result, manufactured products constitute an increasingly larger share of China’s trade. A substantial amount of China’s imports is comprised of parts and components that are assembled in Chinese factories (major products include consumer electronic products and computers), then exported. China’s top 10 exports and imports in 2007 are listed in Tables 8 and 9, respectively, using the harmonized tariff system (HTS) on a four digit level. [14] Table 8. Top 10 Chinese Exports: 2007 HS #

8471

8517 8528

8473 8542

Description Total Exports Automatic data processing machines and units thereof; magnetic or optical readers, machines for transcribing and processing coded data, NESOI Electric apparatus for line telephony etc, parts Television receivers, including video monitors and video projectors Parts etc for typewriters and other office machines Electronic integrated circuits and micro-assemblies; parts thereof

Exports % of Total 2006-2007 % ($billions) Exports Change 1,218.0 100.0 25.7

93.5

7.7

0.5

78.6

6.5

566.2

36.2

3.0

182.4

32.7

2.7

-0.9

24.0

2.0

11.1

China’s Economic Conditions HS # 9013

8443

6110 8504

6204

Description

217

Exports % of Total 2006-2007 % ($billions) Exports Change

Liquid crystal devices nesoi, lasers, optical appliances and instruments, and parts Printing machinery used for printing by means of plates, cylinders and other printing components; other printers, copying machines and facsimile machines, whether or not combined; parts and accessories thereof: printing machinery used for printing by means of plates, cylinders and other printing components Sweaters, pullovers, and vests, etc, knit or crocheted Electrical transformers, static converters (for example, rectifiers) and inductors; parts Women’s or girls’ suits, ensembles, etc. not knit

20.6

1.7

39.2

18.7

1.5

4,548.1

16.0

1.3

24.8

14.2

1.2

29.1

13.4

1.1

7.8

Source: World Trade Atlas. Notes: Harmonized Tariff, four-digit level. NESOI means not elsewhere specified or included.

Table 9. Top 10 Chinese Imports: 2007 HS #

8542 2709 9013

2601

Description Total Electronic integrated circuits and micro-assemblies; parts thereof Crude oil from petroleum and bituminous minerals Liquid crystal devices NESOI; lasers; optical appliances and instruments NESOI; parts and accessories thereof Iron ores and concentrates

Value ($billions) 995.8

% of 2006-2007 % Total Change 100.0 20.8

129.5

13.5

20.8

79.7

8.3

20.0

45.2 33.8

4.7 3.5

25.9 62.5

218

Congressional Research Service Table 9. Continued

HS #

Description

8471

Automatic data processing machines and units thereof; magnetic or optical readers, machines for transcribing and processing coded data, NESOI Electric apparatus for line telephony etc, and parts Parts etc for typewriters & other office machines Parts for television, radio and radar apparatus Oil (not crude) from petrol and bituminous mineral etc. Diodes, transistors and similar devices; photosensitive semiconductor devices; light-emitting diodes; mounted piezoelectric crystals; parts thereof Soybeans

8517 8473

8529 2710 8541

1201

Value ($billions)

% of Total

2006-2007 % Change

20.0

2.1

0.5

18.8

2.0

416.5

17.5

1.8

-8.7

19.7

2.5

18.8

16.3

1.7

5.0

15.6 11.5

1.6 1.2

18.7 53.1

Source: World Trade Atlas. Notes: Harmonized Tariff, four-digit level. NESOI means not elsewhere specified or included.

CHINA’S GROWING ECONOMIC TIES WITH AFRICA, NORTH KOREA, AND IRAN China has sought to expand its trade with countries around the world, especially those that posses energy and raw materials China needs to sustain its rapid economic growth, such as those in Africa. Although China’s trade with these countries is relatively small (compared with its major trading partners), it is growing rapidly. China is also a major trading partner of various countries that pose challenges to U.S. foreign policy, such as Iran, Sudan, and North Korea. [15]


219

CHINA-AFRICA TRADE China’s Imports From Africa China’s imports from Africa as a percent of its total imports grew from 2.8% in 2004 to 3.8% in 2007 (to $36.3 billion). [16] As a whole, Africa was China’s 7th largest source of imports in 2007. China’s imports from Africa grew by 25.9% over the previous year (compared to total Chinese imports growth of 20.8%). Mineral fuels were by far China’s largest import from Africa, accounting for 72% of total imports. Angola was China’s largest source of imports from Africa, accounting for 35% of those imports in 2007, followed by South Africa, Sudan, the Congo, and Equatorial Guinea. China’s imports from Sudan were up 112% over the previous year (see Tables 10 and 11). In 2006, China was Sudan’s largest source of imports (18.2% of total). [17] Table 10. Top Five African Sources of Chinese Imports: 2004-2007 ($ millions) 2004 Africa Total

2005

2006

2007

2006-2007 % Change

15,641

21,114

28,768

36,330

25.9

Angola

4,718

6,581

10,931

12,885

17.9

South Africa

2,955

3,444

4,095

6,608

61.4

Sudan

1,706

2,615

1,941

4,114

111.9

Congo

1,569

2,278

2,785

2,828

1.6

995

1,486

2,538

1,697

-33.1

Equatorial Guinea

Source: World Trade Atlas. Official Chinese statistics.

China’s Mineral Fuel Imports from Africa Africa has become an imported source of China’s surging energy needs. In 2007, 72% of China’s imports from Africa were mineral fuels. China’s fuel imports from Africa rose from $10.1 billion in 2004 to $26.0 billion in 2007. In 2007, Africa supplied 24.8% of China’s imported mineral fuels (compared with 9.1% in 1997). Angola was China’s second largest overall mineral fuel supplier and its largest African supplier. Other major African suppliers (and the world


220

rank) of mineral fuel to China were Sudan (7th), the Congo (12th), Equatorial Guinea (18th), and Libya (19th) (see Table 12). Table 11. Top Five Chinese Imports from Africa: 2004-2007 ($ millions and %) HS 2 Commodity Description

% of Total 2007

2006-2007 % Change

25,997

71.8

23.3

3,298

9.1

55.9

1,196

1,358

3.8

13.5

705

915

2.5

29.8

315

851

2.4

170.6

2004

2005

2006

2007

10,135

14,676

21,083

1,393

1,577

2,116

Precious stones and metals

742

967

Wood

473

524

Iron and steel

439

475

Mineral fuel, oil, etc Ores, slag, ash


Table 12. Top Five African Suppliers of Mineral Fuel to China: 2007

Country Angola

Imports ($millions)

Rank as a Supplier of Mineral Fuel to China

12,876

2

Sudan

4,086

7

Congo

2,307

12

Equatorial Guinea

1,566

18

Libya

1,528

19

Africa Total

25,997

—

Source: Global Trade Atlas.

China’s Exports to Africa The share of Chinese exports going to Africa rose from 2.3% in 2004 to 3.1% in 2007 (to $37.3 billion). [18] If Africa were treated as a single trading partner, it would rank as China’s 7th largest export market in 2007. Exports to Africa grew


221

by 39.7% over the previous year (compared to China’s total exports growth of 25.7%). Major Chinese exports to Africa in 2007 included electrical machinery, machinery (such as computers and components), vehicles (mainly motorcycles and trucks), apparel, and iron and steel products. The top five African destinations of Chinese exports in 2007 were South Africa, Egypt, Nigeria, Algeria, and Morocco (see Tables 13 and 14). In 2006, China was Sudan’s second largest export market (31% of total). [19] Table 13. China’s Top Five African Export Markets: 2004-2007 ($ millions)

Country

2004

2005

2006

2006-2007 % Change

2007

Africa Total

13,815

18,687

26,705

37,314

39.7

South Africa

2,952

3,826

5,769

7,429

28.8

Egypt

1,389

1,935

2,976

4,432

48.9

Nigeria

1,719

2,305

2,856

3,800

33.1

Algeria

981

1,405

1,952

2,709

48.8

Morocco

944

1,206

1,570

2,162

37.8


Table 14. Top Five Chinese Exports to Africa: 2004-2007 ($ millions) HS 2 Commodity Description

% of Total 2007

2006- 2007 % Change

2004

2005

2006

2007

Electrical machinery and parts*

1,905

2,799

4,122

5,806

15.6

40.9

Machinery, mechanical appliances, and parts

1,374

2,141

3,220

4,517

12.1

40.3

Vehicles (excluding railway)

936

1,448

2,023

3,165

8.5

56.4

Knit apparel

828

938

1,537

2,940

7.9

91.3

Iron/steel products

654

903

1,225

1,920

5.1

56.7



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CHINA’S TRADE WITH NORTH KOREA China is North Korea’s largest trading partner and a major supplier of foreign aid (largely in the form of food and fuel). [20] In 2007, Chinese exports to, and imports from, North Korea totaled $1.4 billion and $582 million, respectively. North Korea was China’s 68th largest source of imports (0.06% of total) and its 68th largest export market (0.11% of total). [21] Chinese exports to North Korea rose by 13.0% and imports were up 24.3%, over 2006 levels. China accounted for 37.3% of North Korea’s exports and 39.8% of its imports (2005 data). [22] According to Chinese data, its top five exports to North Korea (2007) were oil, machinery, electrical machinery (such as TVs), plastics, and vehicles (see Table 15), while its top imports from North Korea were ores, coal, woven apparel, fish, and iron and steel (see Table 16). Table 15. Major Chinese Exports to North Korea: 2004-2007 ($ millions and % change) HS 2 Commodity Description

% of Total 2007

2006- 2007 % Change

2004

2005

2006

2007

Electrical machinery and parts*

1,905

2,799

4,122

5,806

15.6

40.9

Machinery, mechanical appliances, and parts

1,374

2,141

3,220

4,517

12.1

40.3

936

1,448

2,023

3,165

8.5

56.4

Vehicles (excluding railway) Knit apparel

828

938

1,537

2,940

7.9

91.3

Iron/steel products

654

903

1,225

1,920

5.1

56.7

Source: World Trade Atlas.

Table 16. Major Chinese Imports from North Korea: 2004-2007 ($ millions and % change) 2004 Total Imports Mineral fuel, oil, etc. (mainly coal) Ores, slag, and ash Woven apparel Iron and steel Fish and seafood

Source: World Trade Atlas.

582 53 59 49 75 261

2005

2006

2007

497 112 92 58 72 92

468 102 118 63 35 43

582 170 164 60 45 30

2006-2007% Change 24.3 55.1 38.5 -4.7 28.2 -30.8


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CHINA’S TRADE WITH IRAN According to the International Monetary Fund (IMF), China was Iran’s largest second trading partner, after EU in 2006. [23] China was Iran’s 4th largest export market (at $9.0 billion), and its 2nd largest source of imports (at $4.9 billion). China has become an increasingly important trading partner for Iran in recent years. Iranian exports to China as a share of its total exports rose from 9.7% in 2002 to 12.9% in 2006, while Iranian imports from China as a share of its total imports increased from 4.7% to 10.6%. Iran constitutes a relatively minor, though growing, trading partner for China. According to Chinese data, Iran was its 16th largest trading partner in 2007. China’s exports to, and imports from, Iran totaled $7.3 billion and $13.3 billion, respectively. China’s exports to Iran rose by 62.1% and imports from Iran were up by 33.7%. China’s top exports to Iran in 2007 were iron and steel ($1.6 billion), machinery ($1.1 billion), vehicles and parts ($880 million). China’s imports from Iran were dominated by crude oil, which totaled $11.6 billion and constituted 87.2% of total Chinese imports. Iran was China’s 3rd largest source of mineral fuels imports in 2007; these constituted 11.1% of China’s total world oil of these products. [24] According to press reports, China’s state-owned oil companies have signed oil and gas deals with Iran worth over $100 billion. [25]

CHINA’S GROWING OVERSEAS DIRECT INVESTMENT A key aspect of China’s economic growth strategy has been to attract foreign investment into China. However, in 2000, China’s leaders initiated a new “go global” strategy, which sought to encourage firms (especially state-owned enterprises) to invest overseas. The Chinese government generally refers to these activities as overseas direct investment (ODI). There appears to be several factors driving this investment: •

China’s massive accumulation of foreign exchange reserves has led government officials to seek more profitable ways of investing these holdings (which traditionally have mainly been put into relatively safe, low yield assets, such as U.S. Treasury securities). On September 29, 2007, the Chinese government officially launched the China Investment Corporation (under the direction of the State Council) in an effort to better manage its foreign exchange reserves. It reportedly will initially


224

•

•

manage over $200 billion, making it one of the world’s largest sovereign wealth funds. Some analysts believe that China will increasingly use its reserves to purchase foreign firms, or shares of foreign firms, that are perceived to be profitable. As a developing country, China has traditionally sought to attract FDI into the country in order to, through joint ventures, gain access to foreign technology and management skills to help domestic firms become more efficient and internationally competitive. Now the Chinese government is attempting to promote the development of internationally recognized Chinese brands. One strategy has been to purchase (or attempt to purchase) existing companies and their internationally-recognized brand names (as well as to obtain technology and management skills). For example, in April 2005 Lenovo Group Limited, a Chinese computer company, purchased IBM Corporation’s personal computer division for $1.75 billion. [26] On June 20, 2005, Haier Group, a major Chinese home appliances manufacturer, made a $1.28 billion bid to take over Maytag Corporation, although the bid was later withdrawn. Acquisition of energy and raw materials has been a major priority of China’s overseas investment strategy. As such, China has sought to either purchase or invest in foreign energy and raw material companies, infrastructure projects (such as oil and gas pipelines, oil refineries, and mines), and joint ventures. [27] For example, in June 2005, the China National Offshore Oil Corporation (CNOOC), through its Hong Kong subsidiary (CNOOC Ltd.), made a bid to buy a U.S. energy company, UNOCAL, for $18.5 billion, although CNOOC later withdrew its bid due to opposition by several congressional Members. In August 2005, the China National Petroleum Corporation (CNPC), China’s largest oil company, purchased PetroKazakhstan Inc., a Canadian-registered company, for $4.2 billion. [28] According to the Eurasia Group, since the 1990s CNPC has signed energy deals with Sudan worth $10 billion, with $4 billion in actual investment. [29]

China reported that its ODI (excluding the finance sector) totaled $16.1 billion (up from $2.9 billion in 2003), up 32% over the previous year, and ranking it as the world’s 13th largest investor. Cumulative ODI totaled $73.3 billion, [30] involving 10,000 approved outbound enterprises. [31] One Chinese official estimated that annual ODI flows could reach $60 billion, with a total cumulation of $120 billion by 2010. [32]


225

Table 17 lists the top 10 destinations for China’s cumulative ODI as of 2005. Hong Kong was by far the major destination (accounting for 64%), followed by the Cayman Island, the British Virgin Islands, South Korea, and the United States. [33] Some analysts contend that much of the ODI going to Hong Kong and Caribbean islands represents “round tipping,” that is investment that is sent overseas but then re-invested elsewhere (including China). Some analysts suspect that some of that capital could be going into tax havens. Table 17. Top 10 Destinations for China’s Overseas Direct Investment: 2005 ($ millions) Country

Cumulative FDI

Hong Kong

36,510

Cayman Islands

8,936

British Virgin Islands

1,984

South Korea

882

United States

823

Macau

599

Australia

587

Russian Federation

466

Sudan

352

Bermuda

337

Total Chinese ODI

5 7 , 2 00

Source: China Statistical Yearbook, 2006.

MAJOR LONG-TERM CHALLENGES FACING THE CHINESE ECONOMY China’s economy has shown remarkable economic growth over the past several years, and many economists project that it will enjoy fairly healthy growth in the near future. However, economists caution that these projections are likely


226

to occur only if China continues to make major reforms to its economy. Failure to implement such reforms could endanger future growth. •

•

•

An inflexible currency policy. China does not allow its currency to float and therefore must make large-scale purchases of dollars to keep the exchange rate within certain target levels. Although the yuan has appreciated someone since reforms were introduced in July 2005, analysts contend that it remains highly undervalued against the dollar. Economists warn that China’s currency policy has made the economy overly dependent on exports and fixed investment for growth and has promoted easy credit policies by the banks. These policies may undermine long-term economic stability by causing overproduction in various sectors, increase the level of non-performing loans held by the banks (see below), and increase inflationary pressures. [34] State-owned enterprises (SOEs), which account for about one-third of Chinese industrial production, put a heavy strain on China’s economy. Over half are believed to lose money and must be supported by subsidies, mainly through state banks. Government support of unprofitable SOEs diverts resources away from potentially more efficient and profitable enterprises. In addition, the poor financial condition of many SOEs makes it difficult for the government to reduce trade barriers out of fear that doing so would lead to widespread bankruptcies among many SOEs. The banking system faces several major difficulties due to its financial support of SOEs and its failure to operate solely on market-based principles. China’s banking system is regulated and controlled by the central government, which sets interest rates and attempts to allocate credit to certain Chinese firms. The central government has used the banking system to keep afloat money-losing SOEs by pressuring state banks to provide low- interest loans, without which a large number of the SOEs would likely go bankrupt. Currently, over 50% of state-owned bank loans now go to the SOEs, even though a large share of loans are not likely to be repaid. The precarious financial state of the Chinese banking system has made Chinese reformers reluctant to open the banking sector to foreign competition. Corruption poses another problem for China’s banking system because loans are often made on the basis of political connections. This system promotes widespread inefficiency in the economy because savings are generally not allocated on the basis of obtaining the highest possible returns.

China’s Economic Conditions •

•

•

227

Growing public unrest. The Chinese government reported that there were over 87,000 protests (many of which became violent) in 2005 (compared with 53,000 protests in 2003) over such issues as pollution, government corruption, and land seizures. [35] A number of protests in China have stemmed in part from frustrations among many Chinese (especially peasants) that they are not benefitting from China’s economic reforms and rapid growth, and perceptions that those who are getting rich are doing so because they have connections with government officials. Protests have broken out over government land seizures and plant shutdowns in large part due to perceptions that these actions benefitted a select group with connections. A 2005 United Nations report stated that the income gap between the urban and rural areas was among the highest in the world and warned that this gap threatens social stability. The report urged China to take greater steps to improve conditions for the rural poor, and bolster education, health care, and the social security system. [36] The lack of the rule of law in China has led to widespread government corruption, financial speculation, and misallocation of investment funds. In many cases, government “connections,” not market forces, are the main determinant of successful firms in China. Many U.S. firms find it difficult to do business in China because rules and regulations are generally not consistent or transparent, contracts are not easily enforced, and intellectual property rights are not protected (due to the lack of an independent judicial system). The lack of the rule of law in China limits competition and undermines the efficient allocation of goods and services in the economy. Recent reports of slave labor in northern China has also raised public anger over the lack of enforcement of labor laws. Poor government regulatory environment. China maintains a weak and relatively decentralized government structure to regulate economic activity in China. Laws and regulations often go unenforced or are ignored by local government officials. As a result, many firms cut corners in order to maximize profits. This has lead to a proliferation of unsafe food and consumer products being sold in China or exported abroad. [37] Growing concerns over the health and safety of Chinese products (such as fish, petfood, tires, and toys) in the United States and other countries could lead consumers to reduce their purchases of Chinese products and could undermine China’s efforts to develop and promote internationally recognized Chinese brands.


228 •

Growing pollution. The level of pollution in China continues to worsen, posing series health risks to the population. The Chinese government often disregards its own environmental laws in order to promote rapid economic growth. According to the World Bank, 20 out of 30 of the world’s most polluted cities are in China, with significant costs to the economy (such as health problems, crop failures and water shortages). According to one government estimate, environmental damage costs the country $226 billion, or 10% of the country’s GDP, each year. The Chinese government estimates that there are over 300 million people living in rural areas that drink unsafe water (caused by chemicals and other contaminants). Toxic spills in 2005 and 2006 threatened the water supply of millions of people.

In October 2006, the Chinese government formally outlined its goal of building a “harmonious socialist society” by taking steps (by 2020) to lessen income inequality, improve the rule of law, beef up environmental protection, reduce corruption, and improve the country’s social safety net (such as expanding health care and pension coverage to rural areas). In March 2007, the Chinese National People’s Congress (NPC) passed a law to strengthen property laws to help prevent local governments from unfairly seizing land from farmers, and in June it passed a new labor contract law to enhance labor rights. In addition, the government has scrambled to improve health and safety laws and regulations.

OUTLOOK FOR CHINA’S ECONOMY AND IMPLICATIONS FOR THE UNITED STATES [38] The short-term outlook for the Chinese economy appears to be positive, but it will likely be strongly influenced by the government’s ability to reform the SOEs and banking system to make them more responsive to market forces, increase the flexibility of its exchange rate policy, and to assist workers who lose their jobs due to economic reforms (in order to maintain social stability). Global Insight, an economic forecasting firm, projects that China’s real GDP will average 7.8% over the next 10 years, indicating that China could double the size of its economy in less than 10 years. Real GDP is projected to rise by 10.9% in 2008. [39] China’s rise as an economic superpower is likely to pose both opportunities and challenges for the United States and the world trading system. China’s rapid economic growth has boosted incomes and is making China a huge market for a


229

variety of goods and services. In addition, China’s abundant low-cost labor has led multinational corporations to shift their export-oriented, labor-intensive manufacturing facilities to China. This process has lowered prices for consumers, boosting their purchasing power. It has also lowered costs for firms that import and use Chinese-made components and parts to produce manufactured goods, boosting their competitiveness. Conversely, China’s role as a major international manufacturer has raised a number of concerns. Many developing countries worry that growing FDI in China is coming at the expense of FDI in their country. Policymakers in both developing and developed countries have expressed concern over the loss of domestic manufacturing jobs that have shifted to China (as well as the downward pressures on domestic wages and prices that may occur from competing against low-cost Chinese-made goods). Many analysts contend that China’s currency policy (despite reforms undertaken in 2005 and the yuan’s gradual appreciation), is having a negative impact on the economies of many of its trading partners (including the U.S.) by artificially making its exports cheaper, and imports more expensive, than they would be under a floating system. They have urged China to move toward a floating exchange rate regime as soon as possible, contending that such a move would benefit China’s economy and those of its trading partners. [40] For example, China’s accumulation of large foreign exchange reserves has forced it to increase the money supply, which may eventually lead to inflationary pressures on the economy. [41] In addition, many analysts contend that easy money policies have led to over-investment in certain economic sectors. However, Chinese officials have expressed concern that further currency reforms, if implemented too quickly, could prove disruptive to the economy. A number of bills have been introduced in the 110th Congress to address Chinese currency policy, including some that would impose sanctions against China. China is attempting to establish and promote companies that can compete globally, especially in advanced technologies. In some cases, China has attempted to purchase large foreign companies. China’s possession of large currency reserves and desire to become a world leader in the production of a variety of goods and strategic commodities will likely lead the Chinese government to expand efforts to take over major international corporations. Many Members charge that China’s use of extensive subsidies to support state-owned firms threatens U.S. economic interests and may violate its WTO commitments. China’s rapid economic growth and continued expansion of its manufacturing base are fueling a sharp demand for energy and raw materials, which is becoming an increasingly important factor in determining world prices for such commodities. China is now the world’s second largest consumer of oil products

230


(after the United States) at 6.9 million barrels per day (bpd) in 2006, and that level is projected to rise to 13.4 million bpd by 2025. [42] The U.S. Energy Information Administration (EIA) predicted that nearly 40% of world oil demand growth in 2006 would come from China. [43] China’s net oil imports in 2006 totaled 2.8 million bpd (up 16.8% over the previous year) and those imports are projected to rise to 10.9 million bpd by 2030. China’s energy needs has become a central part of its foreign policy. Obtaining energy supplies has become a major focus of China’s foreign policy. This has increased concerns among U.S. policymakers for a number of reasons. First, China is becoming increasingly dependent on oil producers in the Persian Gulf region. Currently, China gets about 32% of its oil imports from the region, but by 2030, that level is projected to rise to 53%. This could induce China to become increasingly involved in Middle East affairs. In addition, China is actively involved in gaining greater access to energy in Africa, where it gets nearly a third of its oil imports. Angola was China’s 2nd largest source of oil in 2006. Second, instead of just buying oil in international markets, China has increasingly sought to purchase or invest in foreign oil companies, production facilities, pipelines, oil fields, and refineries around the world. [44] Finally, China’s thirst for oil has led it to obtain agreements with countries the United States has major human rights and foreign policy concerns with (such as Iran and Sudan). Many U.S. policymakers are concerned that China’s energy needs will lead it to oppose U.S. foreign policy objectives and that this could result in increased tensions between the United States and China. A growing concern over China’s energy use and rising demand is the possible global environmental consequences. According to one estimate, one-third of the air pollution in the West Coast of the United States comes from China. [45] China’s pollution levels are expected to significantly worsen. For example, according to the U.S. Energy Information Administration (EIA), China in 2004 was the world’s second-largest emitter of carbon dioxide (CO2) emissions (at 4.7 billion metric tons) after the United States, and constituted 17% of total world emissions (comparted to 22% for the United States). EIA predicts that by the year 2010, China will become the world’s largest emitter, and that by the year 2030, China’s emissions will be 41% greater than U.S. levels. [46] The Netherlands Environmental Assessment Agency estimates that China was in fact the largest CO2 emitter in 2006. [47] Some U.S. policymakers have expressed concern over China’s rising ownership of U.S. government debt, due to fears that China might attempt to use its holdings as leverage in its dealings with the United States on economic and/or political matters. China is the second largest foreign holder of Treasury securities


231

(after Japan), and both the level of those holdings and China’s share of total foreign holdings have increased sharply over the past few years. These went from $51.8 billion in 1999 to $388.6 billion at end of November 2007. [48] China’s U.S. Treasury securities holdings as a share of total foreign holdings over this period have grown from 4.1% to 16.6%. Some have raised concerns that threats by China to halt future purchases, or to sell existing holdings, could cause the value of the dollar to depreciate in world markets (raising import prices), increase U.S. interest rates, lead to a decline in U.S. stock and bond markets, and possibly cause the U.S. economy to slow. However, any such disruption to the U.S. economy would also hurt China’s economy since about a third of China’s exports go to the United States. [49]

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[7]

[8] [9]

The CPI for 2007 was up 4.8% over the previous year (compared with 1.5% in 2006). Xinhua News Agency, July 9, 2007. Calculated by CRS from data in Global Insight’s Country Intelligence on China’sEconomy, Detailed Quarterly Forecast, January 2, 2008. EIU, Business, Industry Overview, China Manufacturing, January 12, 2007. OECD, OECD Economic Surveys, China, 2005, p. 39. In December 2007, the World Bank lowered its previous estimate of China’s 2005 GDPon a PPP basis by 40% (to $5.3 trillion), based on price survey data supplied by the Chinesegovernment for the first time. The new PPP estimates are believed to be more accurate thanthose made previously. See CRS Report RS22808, How Large is China’s Economy? Does it Matter? By Wayne M. Morrison and Michael F. Martin. In 2005, China announced that previous year’s FDI data excluded investment in thebanking, insurance, and securities sectors. It henceforth began to report two overall FDIfigures: one that includes the financial sector and one that excludes it. China’s FDIincluding the financial sector totaled $72.4 billion in 2005, $69.5 billion in 2006, and $82.7billion in 2007. China does not include the financial sector in its country breakdown of FDI. The British Virgin Islands is a large source of FDI because of its status as a tax haven. Much of the FDI originating from the British Virgin Islands and Hong Kong may originatefrom other foreign investors. For example, Taiwanese businesses are believed to invest inChina through other countries in order to circumvent government restrictions. In addition,some Chinese investors might be using these locations to shift funds overseas in order to re-invest in

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[10]

[11] [12] [13] [14]

[15]

[16]

[17]

[18]

Congressional Research Service China to take advantage of preferential investment policies (this practice is oftenreferred to as “round-tipping”). Thus the actual level of FDI in China may be overstated. According to the Chinese government , major U.S. investors in China (based on 2003sales volumes) include Motorola ($5.8 billion in sales volume), General Motors ($2.2billion), Dell Computer ($2.1 billion), Hewlett Packard ($1.3 billion), and Kodak ($0.6billion). Communications equipment, computers, and other electronic equipment accounted for thelargest manufacturing sector for FDI. Xinhua News Agency, August 28, 2007. EIU Industry Wire, April 4, 2007. Rankings and classification descriptions differ according to what tariff classificationsystem is used and at what digit level. HTS digit levels range from two to ten. To illustrate,on a 2-digit HTS level, China’s top five exports in 2007 were electrical machinery,machinery, knit apparel, woven apparel, and iron and steel. China’s top imports on a 2-digitlevel were electrical machinery; machinery; optical, photographic, cinematographic,measuring, checking, precision, medical or surgical instruments and apparatus, and parts andaccessories; and ores. For additional information on policy challenges posed by North Korea, see CRS ReportRL33590, North Korea’s Nuclear Weapons Development and Diplomacy, by Larry A.Niksch; and CRS Report RL32493, the North Korean Economy: Leverage and PolicyAnalysis, by Dick K. Nanto, Emma Chanlett-Avery. For information on policy challengesposed by Sudan, see CRS Report RL33574, Sudan: The Crisis in Darfur and Status of theNorthSouth Peace Agreement, by Ted Dagne. In comparison, U.S. imports from Africa in 2006 were $92.0 billion. Note, the UnitedStates reports import trade data on a customs basis, while China reports imports on a cost,insurance, and freight (C.I.F.) basis. The C.I.F. basis differs from the customs basis in thatthe former includes the cost of insurance and freight and thus raises the value of imports(which the customs basis does not), by about 10%. Central Intelligence Agency, the 2008 World Factbook.14 Rankings and classification descriptions differ according to what tariff classificationsystem is used and at what digit level. HTS digit levels range from two to ten. To illustrate,on a 2-digit HTS level, China’s top five exports in 2007 were electrical machinery,machinery, knit apparel, woven apparel, and iron and steel. China’s top imports on a 2-digitlevel were electrical machinery; machinery; optical, photographic, cinematographic,measuring, checking, precision, medical or surgical instruments and apparatus, and parts andaccessories; and ores. In comparison, total U.S. exports to Africa in 2007 were $23.7 billion (2.0% of total U.S.exports in 2007).


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[19] Central Intelligence Agency, the 2008 World Factbook [20] See CRS Report RL31785, Foreign Assistance to North Korea, by Mark E. Manyin; andCRS Report RL32493, The North Korean Economy: Background and Policy Analysis, byDick K. Nanto and Emma ChanlettAvery. [21] Source: World Trade Atlas. [22] Economist Intelligence Unit, Country Report, North Korea, February 2008, p. 5. [23] China was the largest if EU countries are counted separately. [24] The Iran Daily (July 25, 2007) contended that Iran had become China’s largest source ofoil imports. [25] Reuters News, December 21, 2006. [26] The Chinese government is believed to be the largest shareholder in the company. [27] For a monthly listing of China’s international activities relating to energy and rawmaterials, see China Institute at the University of Alberta at[http://www.uofaweb.ualberta.ca/chinainstitute/index.cfm]. [28] Asia Times, August 24, 2005. [29] Eurasia Group, China’s Overseas Investments in Oil and Gas Production, October 16,2006, p. 20. [30] China Ministry of Foreign Commerce Press Release, January 29, 2007. [31] China Knowledge, June 7, 2007. [32] Anbound-China Market, June 12, 2007 (for estimate of estimated annual flow in 2010)and Glob@l Finance Center, Chinese Outward Direct Investment (ODI), May 5, 2007 (forestimate of cumulative flow in 2010). [33] In terms of regions, Asia accounted for 71.0% of China’s ODI, followed by Latin America(20.0%), Europe (2.8%), Africa (2.8%), North America (2.2%), and Oceania (1.1%). [34] For further information on the economic consequences of China’s currency policy, seeCRS Report RL32165, China’s Currency: Economic Issues and Options for U.S. TradePolicy, by Wayne M. Morrison and Marc Labonte. [35] See CRS Report RL33416, Social Unrest in China, by Thomas Lum. [36] China’s Human Development Report 2005. [37] See CRS Report RS22713, Health and Safety Concerns Over U.S. Imports of ChineseProducts: An Overview, by Wayne M. Morrison. [38] For further discussion of this issue, see CRS Report RL33604, Is China a Threat to theU.S. Economy?, by Craig K. Elwell, Marc Labonte, and Wayne M. Morrison. [39] Global Insight, China: Interim Forecast Analysis: Economic Growth, February 7, 2008. [40] For a discussion of this issue, see CRS Report RS21625, China’s Currency: A Summaryof the Economic Issues, by Wayne M. Morrison and Marc Labonte.

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[41] The government announced in December that the consumer price index in November 2007was up 6.9%, over the same period in 2006 (largely driven by higher food prices, anindicator that inflation may be becoming a problem). [42] Global Insight, Global Petroleum Outlook Forecast Tables (Long-Term), January 2005. [43] U.S. Energy Information Administration website at [http://www.eia.doe.gov/]. [44] See the National Bureau of Asian Research, China’s Search for Energy Security:Implications for the United States, by Kenneth Lieberthal and Mikkal Herberg April 2006. [45] The Aspen Institute, U.S.-China Relations, Eight Conference (April 9-15, 2006), ChinaEnergy Issues, by Hal Harvey, M.S., p. 15. [46] EIA, Country Background, China, Environment, August 2006. [47] The Netherlands Environmental Assessment Agency, Chinese CO2 emissions inPerspective: Country Intercomparison of CO2 Emissions, June 22, 2007, available at[http://www.mnp.nl/en/index.html]. [48] However, from March 2007 to November, China reduced its holdings by $33 billion. [49] See, CRS Report RL34314, China’s Holdings of U.S. Securities: Implications for the U.S.Economy, by Wayne M. Morrison and Marc Labonte.

Chapter 6

CHINA’S CURRENCY: A SUMMARY OF THE ECONOMIC ISSUES *

Congressional Research Service SUMMARY Many Members of Congress charge that China’s policy of accumulating foreign reserves (especially U.S. dollars) to influence the value of its currency constitutes a form of currency manipulation intended to make its exports cheaper and imports into China more expensive than they would be under free market conditions. They further contend that this policy has caused a surge in the U.S. trade deficit with China and has been a major factor in the loss of U.S. manufacturing jobs. Threats of possible congressional action led China to make changes to its currency policy in 2005, which has since resulted in a modest appreciation of the yuan. However, many Members have expressed dissatisfaction with the pace of China’s currency reforms and have warned of potential legislative action. This chapter summarizes the main findings CRS Report RL32165, China’s Currency: Economic Issues and Options for U.S. Trade Policy, by Wayne M. Morrison and Marc Labonte and will be updated as events warrant. From 1994 until July 21, 2005, China maintained a policy of pegging its currency (the renminbi or yuan), to the U.S. dollar at an exchange rate of

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roughly 8.28 yuan to the dollar. The Chinese central bank maintained this peg by buying (or selling) as many dollar-denominated assets in exchange for newly printed yuan as needed to eliminate excess demand (supply) for the yuan. As a result, the exchange rate between the yuan and the dollar basically stayed the same, despite changing economic factors which could have otherwise caused the yuan to either appreciate or depreciate relative to the dollar. Under a floating exchange rate system, the relative demand for the two countries’ goods and assets would determine the exchange rate of the yuan to the dollar. Many economists contend that for the first several years of the peg, the fixed value was likely close to the market value. But in the past few years, economic conditions have changed such that the yuan would likely have appreciated if it had been floating. The sharp increase in China’s foreign exchange reserves (which grew from $403 billion at the end of 2003 to $1.2 trillion at the end of March 2007) and China’s large merchandise trade surplus (which totaled $178 billion in 2006) are indicators that the yuan is significantly undervalued. China Reforms the Peg. The Chinese government modified its currency policy on July 21, 2005. It announced that the yuan’s exchange rate would become “adjustable, based on market supply and demand with reference to exchange rate movements of currencies in a basket,” (it was later announced that the composition of the basket includes the dollar, the yen, the euro, and a few other currencies), and that the exchange rate of the U.S. dollar against the yuan would be immediately adjusted from 8.28 to 8.11, an appreciation of about 2.1%. Unlike a true floating exchange rate, the yuan would (according to the Chinese government) be allowed to fluctuate by 0.3% on a daily basis against the basket.1 Since July 2005, China has allowed the yuan to appreciate steadily but very slowly. It has continued to accumulate foreign reserves at a rapid pace, which suggests that if the yuan were allowed to freely float it would appreciate much more rapidly. The current situation might be best described as a “managed float” — market forces are determining the general direction of the yuan’s movement, but the government is retarding its rate of appreciation through market intervention.

*

This is an edited, reformatted and augmented version of Congressional Research Service Report RS21625, dated July 11, 2007 .

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U.S. CONCERNS OVER CHINA’S CURRENCY POLICY Many U.S. policymakers and business and labor representatives have charged that China’s currency is significantly undervalued vis-à-vis the U.S. dollar (even after the recent revaluation), making Chinese exports to the United States cheaper, and U.S. exports to China more expensive, than they would be if exchange rates were determined by market forces. They further argue that the undervalued currency has contributed to the burgeoning U.S. trade deficit with China (which hit $233 billion in 2006) and has hurt U.S. production and employment in several U.S. manufacturing sectors that are forced to compete domestically and internationally against “artificially” low-cost goods from China. Furthermore, some analysts contend that China’s currency policy induces other East Asian countries to intervene in currency markets in order to keep their currencies weak against the dollar in order to compete with Chinese goods. Critics contend that, while it may have been appropriate for China during the early stages of its economic development to maintain a pegged currency, it should let the yuan freely float today, given the size of the Chinese economy and the impact its policies have on the world economy.

CHINA’S CONCERNS OVER MODIFYING ITS CURRENCY POLICY Chinese officials argue that its currency policy is not meant to favor exports over imports, but instead to foster economic stability through currency stability, as many other countries do. They have expressed concern that floating its currency could spark an economic crisis in China and would especially be damaging to its export industries at a time when painful economic reforms (such as closing down inefficient state-owned enterprises) are being implemented. They further contend that the Chinese banking system is too underdeveloped and burdened with heavy debt to be able to deal effectively with possible speculative pressures that could occur with a fully convertible currency. Concerns have also been raised over the effects an appreciating yuan would have on farmers (due to lower-priced imports). Chinese officials view economic stability as critical to sustaining political stability; they fear an appreciated currency could reduce employment and lower incomes in various sectors, and thus could cause worker unrest. 1 On May 15, 2007, the Chinese government increased the daily band to 0.5%.

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However, Chinese officials have indicated that their long-term goal is to adopt a more flexible exchange rate system and to seek more balanced economic growth through increased domestic consumption and the development of rural areas, but they want to proceed at a gradual pace to ensure economic stability.

IMPLICATIONS OF CHINA’S CURRENCY POLICY FOR ITS ECONOMY If the yuan is undervalued vis-a-vis the dollar (estimates rage from 15 to 40% or higher), then Chinese exports to the United States are likely cheaper than they would be if the currency were freely traded, providing a boost to China’s export industries (and, to some degree, an indirect subsidy). Eliminating exchange rate risk through a managed peg also increases the attractiveness of China as a destination for foreign investment in export-oriented production facilities. However, an undervalued currency makes imports more expensive, hurting Chinese consumers and Chinese firms that import parts, machinery, and raw materials. Such a policy, in effect, benefits Chinese exporting firms (many of which are owned by foreign multinational corporations) at the expense of nonexporting Chinese firms, especially those that rely on imported goods. This may impede the most efficient allocation of resources in the Chinese economy. Another major problem is that the Chinese government must expand the money supply in order to keep purchasing dollars, which has promoted the banks to adopt easy credit policies. In addition, “hot money” has poured into China from investors speculating that China will continue to appreciate the yuan. At some point, these factors could help fuel inflation, overinvestment in various sectors, and expansion of nonperforming loans by the banks — each of which could threaten future economic growth.

IMPLICATIONS OF CHINA’S CURRENCY POLICY FOR THE U.S. ECONOMY Effect on Exporters and Import-Competitors. When exchange rate policy causes the yuan to be less expensive than it would be if it were determined by supply and demand, it causes Chinese exports to be relatively inexpensive and U.S. exports to China to be relatively expensive. As a result, U.S. exports and the production of U.S. goods and services that compete with Chinese imports fall, in

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the short run. (Many of the affected firms are in the manufacturing sector.)2 This causes the trade deficit to rise and reduces aggregate demand in the short run, all else equal.3 Effect on U.S. Consumers and Certain Producers. A society’s economic well-being is usually measured not by how much it can produce, but how much it can consume. An undervalued yuan that lowers the price of imports from China allows the United States to increase its consumption through an improvement in the terms-of-trade. Since changes in aggregate spending are only temporary, from a long-term perspective the lasting effect of an undervalued yuan is to increase the purchasing power of U.S. consumers. Imports from China are not limited to consumption goods. U.S. producers also import capital equipment and inputs to final products from China. An undervalued yuan lowers the price of these U.S. products, increasing their output. Effect on U.S. Borrowers. An undervalued yuan also has an effect on U.S. borrowers. When the U.S. runs a current account deficit with China, an equivalent amount of capital flows from China to the United States, as can be seen in the U.S. balance of payments accounts. This occurs because the Chinese central bank or private Chinese citizens are investing in U.S. assets, which allows more U.S. capital investment in plant and equipment to take place than would otherwise occur. Capital investment increases because the greater demand for U.S. assets puts downward pressure on U.S. interest rates, and firms are now willing to make investments that were previously unprofitable. This increases aggregate spending in the short run, all else equal, and also increases the size of the economy in the long run by increasing the capital stock. Private firms are not the only beneficiaries of the lower interest rates caused by the capital inflow (trade deficit) from China. Interest-sensitive household spending, on goods such as consumer durables and housing, is also higher than it would be if capital from China did not flow into the United States. In addition, a large proportion of the U.S. assets bought by the Chinese, particularly by the central bank, are U.S. Treasury securities, which fund U.S. federal budget deficits. According to the U.S. Treasury Department, China (as of April 2007) held $414 2

3

U.S. production has moved away from manufacturing and toward the service sector over the past several years. U.S. employment in manufacturing as a share of total nonagricultural employment fell from 31.8% in 1960, to 22.4% in 1980, to 10.4% in December 2006. This trend is much larger than the Chinese currency issue, and is caused by changing technology (which requires fewer workers to produce the same number of goods) and comparative advantage. Putting exchange rate issues aside, most economists maintain that trade is a win-win situation for the economy as a whole, but produces losers within the economy. Economists generally argue that free trade should be pursued because the gains from trade are large enough that the losers from trade can be compensated by the winners, and the winners will still be better off.

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billion in U.S. Treasury securities, making China the second largest foreign holder of such securities, after Japan. If the U.S. trade deficit with China were eliminated, Chinese capital would no longer flow into this country on net, and the government would have to find other buyers of U.S. Treasuries. This would likely increase the government’s interest payments. Net Effect on the U.S. Economy. In the medium run, an undervalued yuan neither increases nor decreases aggregate demand in the United States. Rather, it leads to a compositional shift in U.S. production, away from U.S. exporters and import-competing firms toward the firms that benefit from Chinese capital flows. Thus, it is expected to have no medium or long run effect on aggregate U.S. employment or unemployment. As evidence, one can consider that the U.S. had a historically large and growing trade deficit throughout the 1990s at a time when unemployment reached a three-decade low. However, the gains and losses in employment and production caused by the trade deficit will not be dispersed evenly across regions and sectors of the economy: on balance, some areas will gain while others will lose. And by shifting the composition of U.S. output to a higher capital base, the size of the economy would be larger in the long run as a result of the capital inflow/trade deficit. Although the compositional shift in output has no negative effect on aggregate U.S. output and employment in the long run, there may be adverse short-run consequences. If output in the trade sector falls more quickly than the output of U.S. recipients of Chinese capital rises, aggregate spending and employment could temporarily fall. This is more likely to be a concern if the economy is already sluggish than if it is at full employment. Otherwise, it is likely that government macroeconomic policy adjustment and market forces can quickly compensate for any decline of output in the trade sector by expanding other elements of aggregate demand. The deficit with China has not prevented the U.S. economy from registering high rates of growth since 2003. The U.S.-China Trade Deficit in the Context of the Overall U.S. Trade Deficit. While China is a large trading partner, it accounted for only 15.4% of U.S. merchandise imports in 2006 and 26% of the sum of all U.S. bilateral trade deficits. Over a span of several years, a country with a floating exchange rate can consistently run an overall trade deficit for only one reason: a domestic imbalance between saving and investment. Over the past two decades, U.S. saving as a share of gross domestic product (GDP) has been in gradual decline. On the one hand, the U.S. has high rates of productivity growth and strong economic fundamentals that are conducive to high rates of capital investment. On the other hand, it has a chronically low household saving rate, and recently a negative government saving rate as a result of the budget deficit. As long as Americans

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save little, foreigners will use their saving to finance profitable investment opportunities in the United States; the trade deficit is the result.4 The returns to foreign-owned capital will flow to foreigners instead of Americans, but the returns to U.S. labor utilizing foreign-owned capital will flow to U.S. labor.5 Chinese statistics indicated that more than half of its exports to the world are produced by foreign-invested firms in China, many of which have shifted production to China in order to gain access to low-cost labor. (The returns to capital of U.S. owned firms in China flow to Americans.) Such firms import raw materials and components (much of which come from East Asia) for assembly in China. As a result, China tends to run trade deficits with East Asian countries and trade surpluses with countries with high consumer demand, such as the United States. Overall, in 2006, China had a $55 billion trade deficit with the world excluding the United States. These factors imply that much of the increase in U.S. imports (and hence, the rising trade deficit with China) is largely the result of China becoming a production platform for many foreign companies, rather than unfair Chinese trade policies. Most Recent Events. In September 2006, President Bush and President Hu agreed to establish a Strategic Economic Dialogue (SED) in order to have discussions on major economic issues at the “highest official level.” China’s currency policy was a major topic during the first SED meeting held in December 2006 and the second meeting held in May 2007. The two sides agreed to work to reduce global imbalances through increased savings in the United States and increased domestic consumption and exchange rate flexibility in China. However, China refused to agree to any new major changes to its currency policy. From July 21, 2005 to June 11, 2007, the dollar-yuan exchange rate went from 8.11 to 7.57, an appreciation of about 6.7%.

CONGRESSIONAL LEGISLATION Many Members contend that the pace of China’s currency reforms and level of the yuan’s appreciation against the dollar have been too slow, and some have 4

Most economists believe that the United States runs a trade deficit because it fails to save enough to meet its investment needs and must obtain savings from other countries with high savings rates. By obtaining foreign investment (in effect, borrowing), the United States can consume more (including more imports) than it would if investment were funded by domestic savings alone — this results in a trade deficit. 5 China on the other hand has one of the world’s largest savings rate. U.S. officials have urged China to take steps to boost domestic consumption (and hence increase imports).


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introduced legislation to put further pressure on the Chinese to speed reforms or to enable U.S. producers to use U.S. trade law to address the impact of China’s undervalued currency. Summaries of major provisions of these bills are listed below: •

•

•

•

H.R. 321 (English) would increase tariffs on imported Chinese goods if the Treasury Department determined that China manipulated its currency, and would require the United States to file a WTO case against China over its currency policy and to work within the WTO to modify and clarify rules regarding currency manipulation. H.R. 1002 (Spratt) would impose 27.5% in additional tariffs on Chinese goods unless the President certifies that China is no longer manipulating its currency. S. 364 (Rockefeller) would apply U.S. countervailing laws (dealing with government subsidies) to products imported from non-market economies (such as China), and would make currency manipulation actionable under this measure. H.R. 782 (Tim Ryan) and S. 796 (Bunning) would make exchange rate “misalignment” actionable under U.S. countervailing duty laws, require the Treasury Department to determine whether a currency is misaligned in its semi-annual reports to Congress on exchange rates, prohibit the Department of Defense from purchasing certain products imported from China if it is determined that China’s currency misalignment has disrupted U.S. defense industries, and would include currency misalignment as a factor in determining safeguard measures on imports of Chinese products that cause market disruption. H.R. 2942 (Tim Ryan) would apply countervailing laws to nonmarket economies, make an undervalued currency a factor in determining antidumping duties, require Treasury to identify fundamentally misaligned currencies and to list those meeting the criteria for priority action. If consultations fail to resolve the currency issues, the USTR would be required to take action in the WTO. S. 1607 (Baucus) would require the Treasury Department to identify currencies that are fundamentally misaligned and to designate such currencies for “priority action” under certain circumstances. Such action would include factoring currency undervaluation in U.S. anti-dumping cases, banning federal procurement of products or services from the designated country, and filing a case against in the WTO. S. 1677 (Dodd) requires the Treasury Department to identify countries that manipulate their currencies regardless of their intent and to submit an

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action plan for ending the manipulation, and gives Treasury the authority to file a case in the WTO.

INDEX A accounting, 10, 24 age, 12, 21, 35 agricultural, 15, 33 agriculture, 9 air, 10, 18, 19, 52 air quality, 18 alternative, 18, 23, 45 ambient air, 52 analysts, 1, 6, 22, 23, 25, 32, 34, 36, 45, 49, 52, 53 annual rate, vii, 7, 28 appendix, 54 Arabia, 5, 41 Asia, 1, 9, 10, 17, 38, 53 Asian, 2, 26, 38 Asian countries, 38 assessment, 22 assets, 17 assumptions, 3, 47 automakers, 31, 32 automobiles, 36, 37 average costs, 20, 47

B background information, 10, 16, 32, 54 banking, vii barriers, viii

Beijing, 12, 16, 20, 22, 30, 37 benchmark, 20 benefits, 6, 23, 33 bilateral trade, 17 boilers, 8 bottlenecks, 15 British Petroleum, 8, 22 buffer, 41, 42 buildings, 23, 51 Bureau of the Census, 35 burning, 10, 53 buses, 12, 35, 36, 37

C capacity, 6, 9, 15, 17, 18, 21, 38, 39, 40, 41, 42, 46, 47, 50, 52, 53 Capacity, 50 Census, 35 chemicals, 53 China, 1, iii, vii, viii, 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 15, 16, 17, 18, 19, 20, 21, 22, 23, 24, 25, 26, 27, 28, 29, 30, 31, 32, 33, 34, 35, 36, 37, 38, 39, 40, 41, 42, 43, 44, 45, 46, 47, 49, 50, 51, 52, 53 China Daily, 20, 22, 50 classes, 19, 32 clean air, 52 closure, 18 Co, 18

Index

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coal, 9, 30 communication, 36 complexity, 53 components, 39 composition, 3, 35 compounds, 52 configuration, 40, 53 Congressional Budget Office, 1, 3, 15, 32, 42, 51 consensus, 28 conservation, 18, 23, 42 consolidation, 18 constraints, 52 construction, 5, 6, 11, 15, 17, 22, 49, 53 consumer price index, 11 consumers, vii, 20, 22, 29, 43, 44, 50 consumption, 3, 5, 7, 8, 10, 12, 18, 21, 22, 23, 24, 26, 27, 28, 29, 30, 31, 33, 34, 36, 42, 43, 44, 47, 51 contracts, 17 control, 17 conversion, 9 corporate average fuel economy, 32 corruption, vii costs, 5, 6, 7, 20, 21, 22, 28, 34, 37, 38, 39, 40, 43, 46, 47, 50, 51, 52, 53 cracking, 39 credit, 31 crude oil, 1, 2, 5, 6, 8, 17, 18, 20, 22, 23, 37, 38, 39, 40, 41, 42, 43, 44, 45, 46, 47, 51, 52 currency, vii, 25

D decisions, 2, 21, 22 delivery, 46 demographics, 6, 35 Department of Energy, 7, 8, 18, 24, 26, 38, 44, 45, 47, 50 developing countries, 47 diesel, 1, 5, 6, 8, 9, 10, 15, 19, 20, 21, 22, 30, 33, 34, 37, 38, 39, 43, 46, 47, 51, 52, 53 diesel fuel, 5, 6, 8, 9, 19, 22, 30, 33, 34, 37, 38, 39, 51 direct foreign investment, 18

distillates, 8, 27, 28, 30, 39, 51 distillation, 50 distortions, 46 distribution, 18, 21, 30, 46 domestic crude, 20 domestic investment, 21 domestic markets, 52 domestic petroleum, 38

E earnings, 12 East Asia, 10 economic activity, 9, 26, 34 economic development, viii, 32 economic growth, vii, 1, 6, 11, 23, 25, 33, 34, 37, 51, 53 economic reform, vii economic reforms, vii elasticity, 26, 43, 44 elasticity of demand, 26 electric utilities, 30 electricity, 5, 9, 30, 51 emergency response, 42 employees, 17 employment, 5, 12, 15, 35 energy, viii, 1, 3, 5, 6, 9, 12, 17, 20, 21, 23, 24, 30, 34, 41, 44, 49, 54 energy consumption, 3, 12 Energy Information Administration (EIA), 24 energy supply, 17 enterprise, 21 environment, 6 environmental regulations, 47 environmental standards, 39 equity, 17 estimating, 34, 37 ethanol, 51 Europe, 2, 38, 52 excess supply, 53 exchange rate, 15 expertise, 18 exports, vii, 26, 53 Exxon, 40

Index F failure, viii February, 22, 38 Federal Highway Administration, 13, 15, 37 fees, 22, 33 finance, 22 financial institution, 25 financial institutions, 25 financial performance, 17 financial sector, 29 financing, 18 firms, viii, 18 forecasting, 34 Foreign Direct Investment, 18 foreign exchange, vii foreign firms, vii, 21 foreign investment, vii, 18 foreign policy, 17 fossil, 19 fossil fuel, 19 free trade, 46 freight, 10, 12, 15, 51 fuel, 1, 6, 8, 9, 10, 18, 19, 21, 22, 23, 30, 31, 32, 33, 34, 35, 36, 37, 38, 45, 51, 53 fuel efficiency, 19, 22, 31 futures, 20

G gas, 16, 17, 18, 21 gases, 8, 9 gasoline, 1, 3, 5, 6, 8, 9, 10, 18, 19, 20, 21, 22, 27, 28, 29, 30, 33, 34, 37, 38, 39, 43, 46, 47, 51, 52, 53 GDP, vii, 3, 11, 25, 26, 28, 45 generation, 30, 51 generators, 10, 30 Global Insight, 24 global markets, 1 Globalization, 18 goals, 19, 42, 50 goods and services, viii

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government, 3, 6, 12, 15, 17, 18, 19, 20, 21, 22, 23, 24, 25, 29, 31, 32, 33, 34, 35, 49 government revenues, 33 grades, 39, 40 gross domestic product, vii, 3, 24 groups, 24 growth, vii, viii, 1, 2, 3, 5, 6, 7, 8, 10, 11, 12, 15, 17, 18, 23, 24, 26, 27, 28, 29, 30, 31, 33, 34, 35, 36, 37, 43, 44, 45, 46, 47, 49, 51, 52, 53 growth rate, 5, 12, 25, 26 Guangdong, 16 guidelines, 20 Gulf Coast, 50, 52 Gulf War, 42

H handling, 6, 40 heat, 9 heating, 8, 28, 51 heating oil, 8, 51 heavy metal, 54 heavy metals, 54 heavy oil, 9, 10 highways, 15 Hong Kong, 16 households, 11, 37 housing, 35 human, viii human rights, viii hurricane, 52 hydro, 47 hydrocarbons, 47 hydrocracking, 39 hydroelectric power, 9 hydrogen, 47 hydropower, 30

I IEA, 23, 24, 26, 27, 29, 36, 42 IMF, 24, 45 importer, 8

Index

248 imports, vii, 8, 17, 46, 52 incentives, 20 income, vii, 11, 12, 17, 21, 26, 30, 34 incomes, 3, 5, 6, 10, 11, 12, 23, 33 independence, 6 indicators, 34 indirect effect, 26 industrial, 3, 6, 9, 10, 19, 28, 34, 53 industrial sectors, 6, 28, 34 industrialized countries, 21 industry, 6, 16, 17, 18, 19, 38, 40, 49 inefficiency, 18 inflation, 11, 25, 33 inflationary pressures, vii information systems, 31 infrastructure, 11, 15 initiation, vii intensity, 36 interest rates, 31, 46 International Energy Agency, 23, 24, 29, 34, 36, 42, 44, 50 International Monetary Fund, 24, 26, 44, 45 international standards, 19 interstate, 15 inventories, 8, 37, 42, 46, 47 investment, vii, 2, 15, 18, 20, 25, 29, 33, 38, 47, 49, 52, 53 investors, vii, 9, 18 Iran, viii

J Japan, 2, 9, 36 jet fuel, 8, 10 jobs, 11

K Katrina, 29, 50 Kazakhstan, 18 kerosene, 8

L labor, 12 labor force, 12 large-scale, vii Latin America, 52 laws, 19, 52 lending, 31 licenses, 22 light industrial, 34 light trucks, 32, 36 limitation, 47 limitations, 31 liquefied natural gas, 17 loans, 31 local government, 20, 31, 32 location, 21, 40 long period, 50

M maintenance, 22, 23, 33 management, 33 manufacturing, 9, 30 marginal costs, 20 market, 2, 18, 20, 24, 26, 29, 36, 37, 38, 39, 41, 44, 45, 46 market value, 21 marketing, 20 markets, 1, 2, 5, 6, 18, 20, 37, 38, 39, 43, 45, 46, 52 mature economies, 26 measures, 23, 33, 42 merchandise, vii metric, 21 Middle East, 2 migrants, 11 migration, 12, 35 models, 32, 44 momentum, 3, 35 motivation, 18 motorcycles, 15, 35, 36 movement, 35

Index N nation, 16, 17 National Development and Reform Commission, 20 natural, 17, 18, 21, 39 natural gas, 17, 18, 21 NDRC, 20 net exports, 26 New York, 20, 25, 44 New York Mercantile Exchange, 44 North America, 38 North Korea, viii nuclear, 9, 30 nuclear energy, 30 nuclear power, 9, 30

O OECD, 18, 26 offshore, 17 oil, 1, 2, 3, 5, 6, 7, 8, 10, 16, 17, 18, 19, 20, 21, 22, 23, 24, 26, 27, 28, 29, 30, 31, 33, 34, 37, 38, 39, 40, 41, 42, 43, 44, 45, 46, 47, 49, 51, 53 oil production, 5, 6 oil refining, 37 oils, 6, 38, 39, 52 omission, 47 OPEC, 24, 27, 28, 45 Organization for Economic Cooperation and Development, 18 organizations, 3, 29 ownership, 18, 19, 21, 22, 33, 36

P Pacific, 10, 17 paper, 1, 2, 3, 5, 6, 10, 23, 25, 29, 30, 47, 50, 53 Paris, 18 passenger, 12, 31, 32, 35, 36 per capita, 11, 36 performance, 17

249

periodic, 20 personal, 3, 10, 13, 31, 34 personal wealth, 10 petrochemical, 3, 6, 8, 17, 39, 53 petroleum, 1, 2, 3, 5, 6, 7, 8, 9, 10, 16, 17, 18, 19, 20, 23, 28, 29, 33, 38, 43, 44, 45, 47, 50, 51, 52, 53 pipelines, 16, 17, 18 planning, 50 plants, 30, 52 play, vii policy choice, 38 policy initiative, 5 policymakers, vii, 20, 23, 32 pollution, vii population, 3, 6, 11, 12, 15, 28, 30, 34, 35, 36, 51 population growth, 36 power, viii, 9, 30 power plant, 10 power plants, 10 preference, 39 premium, 6, 20, 22, 39 premiums, 38 pressure, vii, 23, 25, 37, 52 price changes, 20, 38, 45 price deflator, 45 price effect, 44 price elasticity, 37, 43 prices, viii, 1, 2, 5, 6, 7, 11, 20, 22, 23, 26, 28, 29, 30, 37, 38, 39, 43, 44, 45, 46, 47, 51 private, 3, 22, 24, 29, 31, 36 producers, 20, 21, 41 production, 8, 9, 16, 17, 18, 19, 21, 41, 42, 44, 49 profitability, 18, 21, 46, 50 profits, 17, 20 program, 18, 31, 32 promote, vii, 18, 23, 32 propane, 21 public, 36

R rail, 10

Index

250

range, 6, 24, 26, 28, 36, 43, 44 raw material, viii, 28 reduction, 5, 44 refineries, 8, 18, 34, 38, 41, 46, 47, 49, 51, 52, 53 refiners, 2, 6, 7, 20, 39, 40, 47, 49, 50, 52, 53 refinery capacity, 6, 17, 38, 39, 50, 53 refining, 5, 6, 9, 16, 17, 18, 19, 21, 28, 37, 38, 40, 46, 47, 50, 51 regulations, 18 relationship, 3, 26, 37, 46, 50, 51 reliability, 30 research, 15, 23, 47 reserves, vii residential, 9, 21, 28, 34 resources, 8, 17 restructuring, 6, 18 retail, 16, 17, 18, 20, 50 revenue, 21 Rita, 29, 50 Roads, 22 rural, 3, 9, 12, 15, 33, 36, 51 rural areas, 12, 15 Russia, 5, 18

S safety, viii sales, 5, 6, 11, 13, 15, 21, 31, 32, 33, 34, 36, 50, 51 Saudi Arabia, 5, 41 savings, 23, 32 security, 44 Senate, 1 services, viii, 21 Shanghai, 16 shares, 17 shipping, 10 short period, 36 short run, 9, 18, 26 short-term, 26, 51 sign, 17 Singapore, 20 social change, 35 social costs, 52

South Asia, 9 speed, 31 stages, 16 standards, 18, 19, 23, 31, 32, 39, 52 Standards, 19, 31, 32 state-owned, viii, 8, 16, 31, 33 statistics, 3, 11, 15, 31, 37 stock, 13, 15, 35, 36, 37, 42, 46, 47 storage, 46 structural changes, 33 subsidies, viii subsidy, 20 Sudan, viii sulfur, 19, 39, 40, 47, 52, 53, 54 suppliers, 17, 21 supply, 6, 17, 24, 30, 37, 41, 42, 43, 44, 45, 47, 50 supply disruption, 41 surplus, vii, 25 systems, 31

T tanks, 46 tax credits, 23 tax rates, 21 taxes, 17, 18, 19, 21, 22, 23 technology, 21 Texas, 44, 45 time, vii, 18, 20, 22, 30, 31, 44, 50, 53 time lags, 20 timing, 42 tolls, 21, 22 total energy, 28 toxic, 53 trade, vii, 6, 17, 21, 46, 47, 53 traffic, 51 trajectory, 45 trans, 7 transmission, 30 transport, 10, 31 transportation, 1, 2, 3, 6, 9, 10, 12, 15, 19, 21, 24, 26, 27, 28, 29, 30, 31, 33, 34, 35, 36, 40, 51 transportation infrastructure, 11

Index travel, 11, 12, 15, 21, 22, 23, 33, 36 travel time, 15 trend, 25 trucking, 51 trucks, 12, 31, 32, 35, 36

U U.S. economy, 6, 23 uncertainty, 45 unemployment, 34 United States, 1, iii, vii, viii, 1, 2, 5, 6, 7, 8, 9, 12, 15, 22, 23, 26, 28, 29, 32, 33, 35, 36, 37, 38, 39, 42, 43, 46, 47, 49, 50, 51, 52, 53 urban areas, 3, 12, 21, 32, 37 urban centers, 10 urban population, 3, 11, 12, 23, 33, 35 urbanization, 35

V value-added tax, 21 values, 44 variable, 33 VAT, 21, 22

251

vehicles, 3, 9, 12, 15, 18, 19, 21, 22, 23, 31, 32, 33, 35, 36, 51 volatility, 5, 37, 38, 41

W Wall Street Journal, 25, 32, 45 Washington Post, 31, 40 waste disposal, 19 water, 10, 19 water quality, 19 wealth, 10 wholesale, 20, 46, 51 women, 12 workers, 10 workforce, 12 World Bank, 10, 22 World Resources Institute, 10, 19, 32 World Trade Organization, viii, 18 WTO, viii

Y yield, 23, 39, 40, 41, 46, 47, 53 yuan, 15, 20, 21, 22, 25

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